REVENUE RULE 93-81

1993-2 C.B. 314, 1993-38 I.R.B. 7.

Internal Revenue Service
Revenue Ruling

CLASSIFICATION OF RHODE ISLAND LIMITED LIABILITY COMPANY

Published: November 29, 1993

§ 7701.--Definitions, 26 CFR 301.7701-2; Associations.

Classification of Rhode Island Limited Liability Company. Because of the flexibility accorded by the Rhode Island Limited Liability Company Act, a Rhode Island limited liability company may be classified as a partnership or as an association taxable as a corporation depending upon the provisions adopted in the limited liability company's articles of organization or operating agreement.

ISSUE

Is M, a Rhode Island 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 Rhode Island Limited Liability Company Act (Act), R.I.Gen.Laws secs. 7-16-1 through 7-16-75 (1993). M is authorized under its articles of organization to engage in any and all business activity permitted by the laws of Rhode Island. M has 25 members. Three of the members, A, B, and C, are the elected managers under M's articles of organization.

§ 7-16-14 of the Act provides that unless the articles of organization or the written operating agreement provide for management by or under the authority of one or more managers in accordance with § 7-16-15, the business and affairs of the LLC shall be managed by the members. § 7-16- 15 of the Act provides that the managers may, but need not, be members. § 7-16-16 of the Act provides that unless otherwise provided in the articles of organization or the operating agreement, managers are elected to fill initial positions or vacancies by majority vote of the members, and any or all managers may be removed, with or without cause, by majority vote of the members.

§ 7-16-23 of the Act provides that a member or manager of an LLC is not liable for the obligations of the LLC solely by reason of being a member or manager.

§ 7-16-34 of the Act provides that a membership interest is personal property. § 7-16-35 of the Act states that unless otherwise provided in the articles of organization or the written operating agreement, a membership interest is assignable in whole or in part. However, an assignment only entitles the assignee to receive the distributions to which the assignor otherwise would be entitled, unless the assignee becomes a member of the LLC pursuant to § 7-16-36.

§ 7-16-36 of the Act provides that except as provided in a written operating agreement, an assignee of an interest in an LLC does not become a member or participate in the management of the LLC unless the other members unanimously consent. Under M's LLC agreement, an assignee of a membership interest will not become a member of M without the consent of all of M's remaining members.

§ 7-16-39 of the Act provides that an LLC is dissolved upon the happening of the first to occur of the following: (1) the date specified in the articles of organization; (2) an event specified in the articles of organization or a written operating agreement to cause dissolution; (3) members voting to dissolve and wind up the LLC; (4) the death, 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 otherwise provided in the articles of organization or a written operating agreement; or (5) entry of a decree of judicial dissolution under § 7-16- 40. M's articles of organization provide that M will dissolve upon the occurrence of any event that terminates the continued membership of a member in M, unless within 90 days all the remaining members of M agree to continue the business.

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 a partnership and an association. 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 exist 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 a partnership or an association. 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, unless otherwise provided in the articles of organization or operating agreement, M is dissolved upon the death, resignation, expulsion, bankruptcy, or dissolution of a member or the occurrence of any other event that terminates the continued membership of a member. M's articles of organization provide that M will dissolve upon the occurrence of any event that terminates the continued membership of a member in M, unless within 90 days all the remaining members of M agree to continue the business. If a member of M ceases to be a member of M for any reason, the continuity of M is not assured because all the 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 M are not liable for M's obligations. 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 the 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 of the attributes of the member's interest in the organization. The characteristic of free transferability does not exist if each member can assign the right to share in the profits without the consent of other members, but cannot assign the member's right to participate in the management of the organization.

Under the Act, a member of M can assign or transfer that member's interest to another who is not a member of the organization. However, under M's LLC agreement, the assignee or transferee does not become a member and does not acquire all the attributes of the member's interest in M unless the remaining members unanimously consent. 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

Because of the flexibility accorded by the Rhode Island Limited Liability Company Act, a Rhode Island limited liability company may be classified as a partnership or as an association taxable as a corporation depending upon the provisions adopted in the limited liability company's articles of organization or operating agreement. See, e.g., Rev.Rul. 93-38, 1993-21 I.R.B. 4 (concerning Delaware limited liability companies). M, the Rhode Island limited liability company considered in this ruling, is classified as a partnership for federal tax purposes because it has associates and an objective to carry on business and divide the gains therefrom but lacks a preponderance of the four remaining corporate characteristics.

DRAFTING INFORMATION

The principal author of this revenue ruling is John Kramer of the Office of Assistant Chief Counsel (Passthroughs and Special Industries). For further information regarding this revenue ruling, contact Mr. Kramer on (202) 622- 3060 (not a toll-free call).