REVENUE RULE 94-5

1994-1 C.B. 312, 1994-2 I.R.B. 21.

Internal Revenue Service
Revenue Ruling

CLASSIFICATION OF LOUISIANA LIMITED LIABILITY COMPANY

Published: January 10, 1994

Section 7701.--Definitions, 26 CFR 301.7701-2: Associations.

Classification of Louisiana limited liability company. Because of the flexibility accorded by the Louisiana Limited Liability Act, a Louisiana 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 Louisiana 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 Louisiana Limited Liability Company Law (Law), La.Rev.Stat.Ann. secs. 12:1301 through 1369 (West 1993). M is authorized under its articles of organization to engage in any and all business activity permitted by the laws of Louisiana. M has 25 members. Three of the members, A, B, and C, are the elected managers under M's articles of organization.

Section 1311 of the Law provides that except as otherwise provided in the articles of organization, the business of the LLC shall be managed by the members, subject to any provision in a written operating agreement restricting or enlarging the management rights and duties of any member or group or class of members. Section 1312 of the Law provides that the articles of organization may provide that the business of the LLC shall be managed by or under the authority of one or more managers who may, but need not, be members. Section 1313 of the Law provides that if management is vested in one or more managers pursuant to section 1312, then, unless otherwise provided in the articles of organization or an operating agreement, the election of managers to fill initial positions or vacancies is by plurality vote of the members.

Section 1320.B of the Law provides that, subject to certain exceptions not relevant to M, no member, manager, employee, or agent of an LLC is liable in such capacity for a debt, obligation, or liability of the LLC.

Section 1329 of the Law provides that a membership interest is an incorporeal moveable. Section 1330 of the Law provides that unless otherwise provided in the articles of organization or an operating agreement, a membership interest is assignable in whole or in part. However, an assignment only entitles the assignee to receive such distribution or distributions, to share in such profits and losses, and to receive such allocation of income, gain, loss, deduction, credit, or similar item to which the assignor was entitled, unless the assignee becomes a member of the LLC pursuant to section 1332.

Section 1332 of the Law provides that except as provided in the articles of organization or 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 in writing. Under M's articles of organization, the assignee of a membership interest in M will not become a member of M unless all of M's remaining members consent.

Section 1334 of the Law provides that except as provided in the articles of organization or a written operating agreement, an LLC is dissolved upon the first to occur of the following: (1) the occurrence of events specified in the articles of organization or operating agreement; (2) the consent of its members; (3) the death, interdiction, withdrawal, 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 within 90 days after the event, the LLC is continued by the unanimous consent of the remaining members (or as otherwise provided in the articles of organization or a written operating agreement) and, if only one member remains, the admission of one or more members. 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

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 §§ 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 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.

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 section 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 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.

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 Law, except as provided in the articles of organization or the operating agreement, an LLC is dissolved upon the death, interdiction, withdrawal, expulsion, bankruptcy, or dissolution of a member or the occurrence of any other event that terminates the continued membership of a member in an LLC, unless within 90 days after the event, an LLC is continued by the unanimous written consent of the remaining members. 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. Thus, 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.

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 Law, 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) 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 Law, the members of an LLC are not liable for an LLC's debts, obligations, or liabilities. 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 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 Law, a member of an LLC can assign or transfer that member's interest to another who is not a member of the organization. However, under M's articles of organization, 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 approve the assignment or transfer. 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 Louisiana Limited Liability Company Law, a Louisiana 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 or operating agreement. See, e.g., Rev. Rul. 93-38, 1993-21 I.R.B. 4 (concerning Delaware LLCs). M, the Louisiana 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 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).