Rev. Proc. 92-33 is applied to LLCs.
Under Rev. Rul. 88-8, an entity organized under foreign laws is classified for Federal tax purposes on the same basis as a domestic organization, using the characteristics in Regs. Sec. 301.7701-2. To be classified as a partnership, an organization must lack at least two of the following four corporate characteristics: (1) limited liability, (2) continuity of life, (3) centralization of management and (4) free transferability of interests.
An organization has continuity of life if the death, insanity, bankruptcy, retirement, resignation or expulsion of any member will not cause its dissolution. Under the applicable foreign law and the company's governing instrument, the LLC in Letter Ruling 9306008 would dissolve on, among other things, the bankruptcy or pursuit of debtor relief by any member. Accordingly, the IRS held that the company lacked continuity of life.
An organization has free transferability of interests if each member or those members with substantially all of its interests have the power, without the consent of other members, to substitute for themselves a person who is not a member of the organization. Under Rev. Proc. 92-33, the Service will rule that a partnership lacks free transferability of interests if, throughout its life, the partnership agreement expressly restricts the transfer of interests representing more than 20% of all interests in partnership capital, income, gain, loss, deduction and credit.
In Letter Ruling 9306008, under the applicable foreign law, the LLC's governing instrument could condition transfer of interests on the company's consent, or restrict disposition in other ways. The company's governing instrument generally provided for disposition of membership interests with the consent of the other members. However, there was an exception for the interests of one specified member, and this member's interest represented less than 80% of all the interests in the capital, income, gain, loss, deductions and credits throughout the company's life. Accordingly, the company lacked free transferability of interests.
The application of Rev. Proc. 92-33 to partnerships, other than in the context of obtaining a ruling, has not been clear. Its provisions are not intended to be substantive rules; moreover, it specifically refers only to partnerships and partnership agreements. Letter Ruling 9306008 clarifies that Rev. Proc. 92-33 may equally apply to LLCs.
In appropriate situations, an LLC can be a good vehicle for entities wishing to restrict ownership. A direct limitation on transferability can effectively limit the transfer of interests and the number of investors. Alternatively, by applying Rev. Proc. 92-33, an LLC can remove much of the limitation on transfer of investors' interests while still lacking free transferability of interests.
For example, an LLC could be formed with two classes of members, a management class and an investment class. The management class with an aggregate interest greater than 20%, can only transfer its interests subject to the consent of the other members. The investor class, with less than an aggregate 80% interest, could transfer its interests without restriction.
While Letter Ruling 9306008 goes a long way in clarifying Rev. Proc. 92-33, there are still uncertainties. A partnership or LLC that relies on Rev. Proc. 92-33 would be well-advised to seek a letter ruling on its status for Federal tax purposes.
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|Title Annotation:||limited liability companies|
|Publication:||The Tax Adviser|
|Date:||Jun 1, 1993|
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