Rev. Rul. 93-92, 1993-2 C.B. 318, 1993-42 I.R.B. 11.

Internal Revenue Service
Revenue Ruling

CLASSIFICATION OF OKLAHOMA LIMITED LIABILITY COMPANY

Published: December 27, 1993

Section 7701. - Definitions, 26 CFR 301.7701-2: Associations.
Classification of Oklahoma limited liability company. Because of the flexibility accorded by the Oklahoma Limited Liability Company Act, an Oklahoma 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, an Oklahoma 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 Oklahoma Limited Liability Company Act (Act), Okla.Stat.Ann., tit. 18, ss 2000 through 2060 (West Supp.1994). M is authorized under its articles of organization to engage in any and all business activity permitted by the laws of Oklahoma. M has 25 members. Three of the members, A, B, and C, are the elected managers under M's articles of organization.

Section 2013 of the Act provides that except as otherwise provided in the articles of organization, operating agreement, or the Act, an LLC shall be managed by or under the authority of one or more managers who may but need not be members.

Section 2015 of the Act allows the articles of organization or the operating agreement to provide that the business of the LLC shall be managed without designated managers. In that event, the members are deemed to be managers for purposes of the Act (unless the articles or the operating agreement clearly requires otherwise) and shall have and be subject to all duties and liabilities of managers. The Act further provides that a member signing on behalf of the LLC shall sign as a manager.

Section 2022 of the Act provides that a person who is a member or manager, or both, of an LLC is not liable for the obligations of the LLC solely by reason of being a member or manager or both.

Section 2032 of the Act provides that a membership interest is personal property.

Section 2033 of the Act provides that unless otherwise provided in the articles of organization or the operating agreement, a membership interest is assignable in whole or in part. An assignment of a membership interest does not, of itself, dissolve the LLC or entitle the assignee to participate in the management and affairs of the LLC or to become or to exercise any rights or powers of a member. An assignment entitles the assignee to receive the distribution or distributions to which the assignor was entitled to the extent assigned. Until the assignee of an LLC interest becomes a member, the assignor continues to be a member and to have the power to exercise any rights of a member, subject to the remaining members' right to remove the assignor pursuant to section 2036. The removal of an assignor does not, however, cause the assignee to become a member. Until an assignee of a membership interest becomes a member, the assignee has no liability as a member solely as a result of the assignment, and the assignor of a membership interest is not released from liability as a member solely as a result of the assignment.

Section 2035 of the Act provides that an assignee of an interest in an LLC may become a member if and to the extent that the articles of organization or the operating agreement so provide, or the members consent in writing. For this purpose, consent must be reflected by members holding a majority of the capital interests. An assignee who becomes a member has the rights and powers, and is subject to the restrictions and liabilities, of a member under the articles of organization, the operating agreement, and the Act

Section 2020 of the Act provides that unless otherwise provided in the articles of organization or the operating agreement, the members of an LLC shall vote in proportion to their respective capital interests. For this purpose, the term "capital interest" is defined in the Act as the fair market value as of the date contributed of a member's capital contribution as adjusted for any additional capital contributions or withdrawals. Under M's articles of organization and its operating agreement, an assignee of a membership interest only may become a member upon the consent of the members holding a majority of the capital interests.

Section 2037 of the Act provides that an LLC is dissolved and its affairs shall be wound up upon the earlier of the time or the occurrence of events specified in writing in the articles of organization or the operating agreement; the written consent of all of the members; an event of dissociation of a member, unless the LLC is continued either by the unanimous consent of the remaining members within 90 days following the occurrence of the event or as otherwise provided in writing in the operating agreement; or the entry of a decree of judicial dissolution under section 2038.

Section 2001 of the Act provides that the term "event of dissociation" means an event that causes a person to cease to be a member, as provided in section 2036.

Section 2036 of the Act sets forth several events of dissociation, including the withdrawal or removal of a member, and, subject to the operating agreement or the written consent of all other members, the bankruptcy, death, incompetency, or dissolution of a member. In addition, the operating agreement may provide for other events the occurrence of which will terminate the continued membership of a member in the LLC. M's operating agreement provides that M dissolves upon the withdrawal, removal, bankruptcy, death, incompetency, or dissolution of a member unless within 90 days all of the remaining members consent to continue M.

LAW AND ANALYSIS

Section 7701(a)(2) 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 ss 301.7701-2 through 301.7701-4.

Section 301.7701-2(a)(1) 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) 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) provides that if an unincorporated organization possesses more corporate characteristics than noncorporate characteristics, it constitutes an association taxable as a corporation.

In interpreting s 301.7701-2, 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) 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) 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 M is continued by the unanimous consent of the remaining members, M is dissolved upon the withdrawal, removal, bankruptcy, death, incompetency, or dissolution of a member. If one of the foregoing events occurs, 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.

Section 301.7701-2(c)(1) 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) 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) 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 M's articles of organization and operating agreement, 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) 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 and managers of an LLC are not liable for the LLC's obligations solely by reason of being a member or manager. Consequently, M possesses the corporate characteristic of limited liability.

Section 301.7701-2(e)(1) 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, 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 who is not a member of the organization. However, under M's articles of organization and operating agreement, the assignee does not become a member and does not acquire all of the attributes of the member's interest in M unless the members holding a majority of the capital interests 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 Oklahoma Limited Liability Company Act, an Oklahoma 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 LLCs). M, the Oklahoma 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 David McDonnell of the Office of Assistant Chief Counsel (Passthroughs and Special Industries). For further information regarding this revenue ruling, contact Mr. McDonnell on (202) 622- 3050 (not a toll-free call).

Rev. Rul. 93-92, 1993-2 C.B. 318, 1993-42 I.R.B. 11.