REVENUE RULE 93-50

1993-2 C.B. 310, 1993-25 I.R.B. 13.

Internal Revenue Service
Revenue Ruling

CLASSIFICATION OF WEST VIRGINIA LIMITED LIABILITY COMPANY

Published: July 19, 1993

26 CFR 301.7701-2: Associations.

Classification of West Virginia limited liability company. An unincorporated organization operating under the West Virginia Limited Liability Company Act is classified as a partnership for Federal tax purposes under § 301.7701-2 of the regulations.

ISSUE

Is M, a West Virginia limited liability company, classified for federal tax purposes as an association or as a partnership under § 7701 of the Internal Revenue Code?

FACTS

M is organized as a limited liability company (LLC) pursuant to the provisions of the West Virginia Limited Liability Company Act (Act), W.VA.CODE §§ 31-1A-1 through 31-1A-69 (Supp.1992). M is authorized under its articles of organization to engage in any and all business activity permitted by the laws of West Virginia. M has 25 members, including A, B, and C who are the elected managers under M's articles of organization.

§ 31-1A-18 of the Act provides that except to the extent that the articles of organization or an operating agreement provides for management of an LLC by a manager or managers, management of an LLC is vested in its members. Unless otherwise provided in the articles of organization or an operating agreement, the members of an LLC vote in proportion to their contributions to the LLC, as adjusted from time to time to reflect any additional contributions or withdrawals.

§ 31-1A-20 of the Act permits management by managers and provides that managers are elected by the members and, unless otherwise provided in the articles of organization or an operating agreement, any vacancy occurring in the position of manager is filled by a majority vote in interests of the members.

§ 31-1A-33 of the Act provides that the members of an LLC have the same rights and liabilities as shareholders of corporations organized or registered under the West Virginia Corporation Act.

§ 31-1A-34(a) of the Act provides that a membership interest in an LLC is personal property. § 31-1A-34(b) provides that unless otherwise provided in the articles of organization or an operating agreement, a membership interest in an LLC is assignable in whole or in part. Assigning an interest does not of itself dissolve the LLC and does not entitle the assignee to participate in the management and affairs of the LLC or to become or to exercise any rights of a member. An assignment entitles the assignee to receive, to the extent assigned, only the share of profits and losses and distributions to which the assignor would be entitled. Except as provided in the articles of organization or an operating agreement, a member ceases to be a member upon assignment of that member's entire membership interest. § 31- 1A-34(c)(1) provides that an assignee of an LLC interest may become a member only if the other members unanimously consent.

§ 31-1A-35 of the Act provides that an LLC is dissolved upon the occurrence of any of the following events: (1) when the period fixed for the duration of the LLC expires; (2) by the unanimous written consent of all members; (3) upon the death, retirement, resignation, expulsion, bankruptcy, or dissolution of a member or the occurrence of any other event that terminates the continued membership of a member in the LLC, unless the business of the LLC is continued by the consent of all the remaining members under a right to do so stated in the articles of organization of the LLC; or (4) the entry of a decree of judicial dissolution.

M's articles of organization provide that M dissolves upon the death, retirement, resignation, expulsion, bankruptcy, or dissolution of any of M's members unless all of M's remaining members agree to continue M.

LAW AND ANALYSIS

§ 7701(a)(2) of the Code provides that the term "partnership" includes a syndicate, group, pool, joint venture, or other unincorporated organization, through or by means of which any business, financial operation, or venture is carried on, and which is not a trust or estate or a corporation.

§ 301.7701-1(b) of the Procedure and Administration Regulations states that the Code prescribes certain categories, or classes, into which various organizations fall for purposes of taxation. These categories, or classes, include associations (which are taxable as corporations), partnerships, and trusts. The tests, or standards, that are to be applied in determining the classification in which an organization belongs are set forth in sections 301.7701-2 through 301.7701-4.

§ 301.7701-2(a)(1) of the regulations sets forth the following major characteristics of a corporation: (1) associates, (2) an objective to carry on business and divide the gains therefrom, (3) continuity of life, (4) centralization of management, (5) liability for corporate debts limited to corporate property, and (6) free transferability of interests. Whether a particular organization is to be classified as an association must be determined by taking into account the presence or absence of each of these corporate characteristics.

§ 301.7701-2(a)(2) of the regulations provides that an organization that has associates and an objective to carry on business and divide the gains therefrom is not classified as a trust, but rather as a partnership or association taxable as a corporation. It further provides that characteristics common to partnerships and corporations are not material in attempting to distinguish between an association and a partnership. Since associates and an objective to carry on business and divide the gains therefrom are generally common to corporations and partnerships, the determination of whether an organization that has these characteristics is to be treated for tax purposes as a partnership or as an association depends on whether there exists centralization of management, continuity of life, free transferability of interests, and limited liability.

§ 301.7701-2(a)(3) of the regulations provides that if an unincorporated organization possesses more corporate characteristics than noncorporate characteristics, it constitutes an association taxable as a corporation.

In interpreting § 301.7701-2 of the regulations, the Tax Court, in Larson v. Commissioner, 66 T.C. 159 (1976), acq., 1979-1 C.B. 1, concluded that equal weight must be given to each of the four corporate characteristics of continuity of life, centralization of management, limited liability, and free transferability of interests.

In the present situation, M has associates and an objective to carry on business and divide the gains therefrom. Therefore, M must be classified as either an association or a partnership. M is classified as a partnership for federal tax purposes unless the organization has a preponderance of the remaining corporate characteristics of continuity of life, centralization of management, limited liability, and free transferability of interests.

§ 301.7701-2(b)(1) of the regulations provides that if the death, insanity, bankruptcy, retirement, resignation, or expulsion of any member will cause a dissolution of the organization, continuity of life does not exist. § 301.7701-2(b)(2) provides that an agreement by which an organization is established may provide that the business will be continued by the remaining members in the event of the death or withdrawal of any member, but the agreement does not establish continuity of life if under local law the death or withdrawal of any member causes a dissolution of the organization.

Under the Act and the articles of organization, unless the business of M is continued by the consent of all the remaining members, M is dissolved upon the death, retirement, resignation, expulsion, bankruptcy, or dissolution of a member or the occurrence of any other event that terminates the continued membership of a member in the company. If a member of M ceases to be a member of M for any reason, the continuity of M is not assured because all remaining members must agree to continue the business. Consequently, M lacks the corporate characteristic of continuity of life.

§ 301.7701-2(c)(1) of the regulations provides that an organization has the corporate characteristic of centralized management if any person (or group of persons that does not include all the members) has continuing exclusive authority to make management decisions necessary to the conduct of the business for which the organization was formed.

§ 301.7701-2(c)(2) of the regulations provides that the persons who have this authority may, or may not, be members of the organization and may hold office as a result of a selection by the members from time to time, or may be self-perpetuating in office. Centralized management can be accomplished by election to office, by proxy appointment, or by any other means that has the effect of concentrating in a management group continuing exclusive authority to make management decisions.

§ 301.7701-2(c)(4) of the regulations provides that there is no centralization of continuing exclusive authority to make management decisions, unless the managers have sole authority to make the decisions. For example, in the case of a corporation or a trust, the concentration of management powers in a board of directors or trustees effectively prevents a stockholder or a trust beneficiary, simply because that person is a stockholder or beneficiary, from binding the corporation or the trust.

Under the Act, an LLC may be managed either by an elected manager or managers or by its members. Under the articles of organization, M is managed by its elected managers A, B, and C. Therefore, M possesses the corporate characteristic of centralized management.

§ 301.7701-2(d)(1) of the regulations provides that an organization has the corporate characteristic of limited liability if under local law there is no member who is personally liable for the debts of, or claims against, the organization. Personal liability means that a creditor of an organization may seek personal satisfaction from a member of the organization to the extent that the assets of the organization are insufficient to satisfy the creditor's claim.

Under the Act, the members of an LLC have the same rights and liabilities as shareholders of corporations formed under the West Virginia Corporation Act. § 31-1-89 of the West Virginia Corporation Act provides that a holder or subscriber to shares of a corporation is under no obligation to the corporation or its creditors with respect to those shares other than the obligation to pay to the corporation the full consideration for which the shares are issued. Consequently, M possesses the corporate characteristic of limited liability.

§ 301.7701-2(e)(1) of the regulations provides that an organization has the corporate characteristic of free transferability of interests if each of its members or those members owning substantially all of the interests in the organization have the power, without the consent of other members, to substitute for themselves in the same organization a person who is not a member of the organization. For this power of substitution to exist in the corporate sense, the member must be able, without the consent of other members, to confer upon the member's substitute all the attributes of the member's interest in the organization. The characteristic of free transferability does not exist if each member can, without the consent of the other members, assign only the right to share in the profits but cannot assign the right to participate in the management of the organization.

Under the Act, a member of M can assign that member's interest to another person who is not a member of the organization. However, the assignee does not become a substitute member and does not acquire all the attributes of the member's interest in M unless all of the remaining members approve the assignment. Therefore, M lacks the corporate characteristic of free transferability of interests.

M has associates and an objective to carry on business and divide the gains therefrom. In addition, M possesses the corporate characteristics of centralized management and limited liability. M does not, however, possess the corporate characteristics of continuity of life and free transferability of interests.

HOLDING

M has associates and an objective to carry on business and divide the gains therefrom but lacks a preponderance of the four remaining corporate characteristics. Accordingly, M, a West Virginia limited liability company, is classified for federal tax purposes as a partnership under § 7701 of the Code.

DRAFTING INFORMATION

The principal author of this revenue ruling is Brad K. Saunders of the Office of Assistant Chief Counsel (Passthroughs and Special Industries). For further information regarding this revenue ruling contact Brad K. Saunders on (202) 622-3050 (not a toll-free call).

Rev. Rul. 93-50, 1993-2 C.B. 310, 1993-25 I.R.B. 13.