Rev. Rul. 93-91, 1993-2 C.B. 316, 1993-41 I.R.B. 22.

Internal Revenue Service
Revenue Ruling

CLASSIFICATION OF UTAH LIMITED LIABILITY COMPANY

Published: December 20, 1993

Section 7701. - Definitions, 26 CFR 301.7701-2: Associations
Classification of Utah limited liability company. Because of the flexibility accorded by the Utah Limited Liability Company Act, a Utah 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 Utah limited liability company, classified for federal tax purposes as an association or as a partnership under section 7701 of the Internal Revenue Code?

FACTS

M is organized as a limited liability company (LLC) pursuant to the provisions of the Utah Limited Liability Company Act (Act), Utah Code Ann. ss 48-2b-101 through 48-2b-157 (Supp.1992). M is authorized under its articles of organization to engage in any and all business activity permitted by the laws of Utah. M has 25 members. Three of the members, A, B, and C, are the elected managers under M's articles of organization.

Section 48-2b-125(1) of the Act provides that the management of the LLC, unless otherwise provided in the articles of organization, is vested in its members in proportion to their interests in the profits of the LLC, as reflected in the operating agreement and as adjusted from time to time to properly reflect any additional contributions or withdrawals by the members. If the management of the LLC is vested in the members, any member has authority to bind the LLC, unless otherwise provided in the articles of organization.

Section 48-2b-125(2) of the Act provides that if the articles of organization provide for the management of the LLC by a manager or managers, the manager or managers shall be any person elected by the members in the manner prescribed by and provided for in the operating agreement. If the management of the LLC is vested in a manager or managers, any manager has authority to bind the LLC, unless otherwise provided in the articles of organization. A manager shall serve for a term specified in the operating agreement. This term may not exceed the duration of the LLC as specified in the articles of organization.

Section 48-2b-109 of the Act provides that, except as specifically set forth in the Act, neither the members, the managers, nor the employees of an LLC are personally liable under a judgement, decree, or order of a court, or in any other manner, for a debt, obligation, or liability of the LLC.

Section 48-2b-111 of the Act provides that the Act does not alter any law applicable to the relationship between a person rendering professional services and a person receiving those services, including liability arising out of those professional services. All persons rendering professional services shall remain personally liable for any results of that person's acts or omissions. No member, manager, or employee of an LLC is personally liable for the acts or omissions of any other member, manager, or employee of the LLC.

Section 48-2b-131(1) of the Act provides that an interest of a member in an LLC may be adjusted, transferred, or assigned as provided in the operating agreement. However, if the nontransferring members entitled to receive a majority of the nontransferred profits of the LLC, pursuant to Section 48-2b-130, do not consent to the proposed transfer or assignment, the transferee of the interest of the member has no right to participate in the management of the business and affairs of the LLC or to become a member. In that event, the transferee is entitled to receive only the share of profits or other compensation by way of income and the return of contributions to which that member would otherwise be entitled.

Section 48-2b-137 of the Act provides that an LLC organized under the Act shall be dissolved upon the occurrence of any of the following events: (1) when the period fixed for the duration of the LLC in its articles of organization or operating agreement expires; (2) by written agreement signed by the members entitled to receive a majority of the profits of the LLC, unless otherwise provided in the operating agreement; (3) except as provided otherwise in the operating agreement, upon the death, retirement, resignation, expulsion, bankruptcy, or dissolution of a member or upon the occurrence of any other event that terminates the continued eligibility for membership of a member in the LLC, unless the business of the LLC is continued by the members: (a) under a right to continue the business, as provided in the operating agreement, but only in accordance with the terms, conditions, and provisions specified in the operating agreement; or (b) if the right to continue is not specified in the operating agreement, by the consent of all the remaining members within 90 days after the event of termination; or (4) when the LLC is not the successor LLC in the merger or consolidation of two or more LLCs. Under M's operating agreement, upon the withdrawal of a member, the consent of a majority in interest of the remaining members must be obtained to continue the business of M.

LAW AND ANALYSIS

Section 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.

Section 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.

Section 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.

Section 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 exist centralization of management, continuity of life, free transferability of interests, and limited liability.

Section 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 section 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.

Section 301.7701-2(b)(1) of the regulations provides that if the death, insanity, bankruptcy, retirement, resignation, expulsion, or other event of withdrawal of a general partner of a limited partnership causes a dissolution of the partnership, continuity of life does not exist; furthermore, continuity of life does not exist notwithstanding the fact that a dissolution of the limited partnership may be avoided, upon such an event of withdrawal of a general partner, by the remaining general partners agreeing to continue the partnership or by at least a majority in interest of the remaining partners agreeing to continue the partnership. See Glensder Textile Co. v. Commissioner, 46 B.T.A. 176 (1942), acq., 1942-1 C.B. 8.

In Glensder Textile, the court concluded that a limited partnership lacked continuity of life because upon the death, retirement, or incapacity of a general partner, the remaining general partners would have to agree to continue the partnership, and there was no assurance that they would do so. The court noted that the contingent continuity of a partnership was not analogous to the chartered life of a corporation, which continues regardless of the death or resignation of its directors or stockholders. Section 301.7701-2(b)(1) of the regulations provides that a limited partnership lacks continuity of life even though a dissolution may be avoided by at least a majority in interest of the remaining partners agreeing to continue the partnership. Although the regulation and Glensder Textile specifically address the dissolution of a limited partnership, the contingent continuity of life concept reflected in the regulation and Glensder Textile applies in classifying LLCs.

Under the Act and M's operating agreement, unless the business of M is continued by consent of a majority in interest of 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 a majority in interest of the remaining members must agree to continue the business. Consequently, M lacks the corporate characteristic of continuity of life.

Section 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.

Section 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.

Section 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.

Section 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 debts, obligations, or liabilities. Consequently, M possesses the corporate characteristic of limited liability.

Furthermore, if M were an LLC providing professional services, the members would not be liable for the debts of, or claims against, M. Under section 48- 2b-111, the members would only have personal liability in connection with that member's performance of professional services on behalf of M. Therefore, in that situation, M would also possess the corporate characteristic of limited liability.

Section 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 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 or transfer that member's interest to another who is not a member of the organization. However, 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 nontransferring members entitled to receive a majority of the nontransferred profits of the LLC consent to the transfer or assignment. Without the consent of these non-transferring members, the transferee of the interest has no right to participate in the management of the business and affairs of the LLC or to become a member. In that event, the transferee is entitled to receive only the share of profits or other compensation by way of income and the return of contributions to which the transferor would otherwise be entitled. 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 Utah Limited Liability Company Act, a Utah LLC may be classified as a partnership or as an association taxable as a corporation depending upon the provisions adopted in the LLC'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 Utah LLC 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 Scott N. Carlson of the Office of Assistant Chief Counsel (Passthroughs and Special Industries). For further information regarding this revenue ruling, contact Mr. Carlson on (202) 622- 3050 (not a toll-free call).

Rev. Rul. 93-91, 1993-2 C.B. 316, 1993-41 I.R.B. 22.