Favorable Tax Ruling for Colorado's Limited Liability Company Statute
| Publication year | 1993 |
| Pages | 304 |
| Citation | Vol. 22 No. 2 Pg. 304 |
1993, February, Pg. 304. Favorable Tax Ruling for Colorado's Limited Liability Company Statute
On December 24, 1992, the Internal Revenue Service ("IRS") released Revenue Ruling ("Rev. Rul.") 93-6,(fn1) which confirms that a limited liability company ("LLC") organized under the Colorado Limited Liability Company Act ("CLLCA")(fn2) will be treated as a partnership for federal income tax purposes. This ruling is important not only as a confirmation of the tax status of LLCs formed under the Colorado statute, but, in conjunction with another public ruling released the same day,(fn3) as a statement of the government's continued approval of partnership treatment for LLCs. This article discusses the ruling, a copy of which is included in the Appendix to this article.
An LLC is an unincorporated organization that is intended to combine the tax benefits and flexibility of a partnership with limited liability for the owners. Wyoming enacted the first limited liability company statute in 1977; Florida enacted a statute in 1982. Nonetheless, the uncertainty of tax treatment discouraged the use of LLCs until 1988, when Rev. Rul. 88-76(fn4) was issued. Rev. Rul. 88-76 held that a Wyoming LLC would be treated as a partnership for tax purposes.
In order for an LLC to be taxed as a partnership, it must lack at least two of four corporate characteristics: limited liability, centralization of management, free transferability and continuity of life.(fn5) The Wyoming LLC considered in the ruling lacked (1) continuity of life because it dissolved on the death, retirement, resignation, expulsion, bankruptcy, dissolution of a member or the occurrence of any other event that terminated the continued membership of a member in the LLC (a "Withdrawal Event") and (2) free transferability of interests because no member could transfer all of that member's rights in the LLC without the consent of the other members.
The CLLCA, which was enacted in April 1990, made Colorado the third state to adopt LLC legislation and the first to do so after the issuance of Rev. Rul. 88-76. Fifteen additional states have since adopted LLC legislation.(fn6) Two others have statutes recognizing, or at least acknowledging the existence of, LLCs,(fn7) and several other states are considering such statutes.
The CLLCA was drafted with the intention that LLCs organized under it would be entitled to a favorable ruling for the same reasons that the Wyoming LLC obtained its ruling. To that end, language was included similar to that of the Wyoming statute dealing with dissolution(fn8) and transfer of interests.(fn9) Nevertheless, caution and the newness of the organization caused some to advise using a Wyoming LLC or obtaining a private ruling until a Colorado LLC had obtained a public ruling.(fn10)
One way to assure that an organization will be treated as a partnership for tax purposes is to obtain a private letter ruling. A private letter ruling, issued by the IRS, has no precedential value to any party but the taxpayer requesting it.(fn11) On the other hand, a public ruling such as Rev. Rul. 88-76 may be relied on
After the enactment of the CLLCA, the Colorado Bar Association Tax Section and its Drafting Committee(fn12) considered ways in which to obtain government approval of the act. Following discussions with the IRS, the Drafting Committee determined to request a public ruling. A limited liability company was formed by the Drafting Committee and was submitted to the IRS in September 1990. Although all the indications from the people reviewing the ruling request were to the effect that the ruling would be favorable, the ruling was not issued for more than two years after it was requested.
Since 1988, favorable private letter rulings have been obtained for LLCs in Florida, Kansas, Nevada, Utah and Texas.(fn13) However, the rulings released on December 24, 1992, represent the first public rulings on the tax treatment of LLCs since Rev. Rul. 88-76.
Rev. Rul. 93-6 considers a Colorado LLC in which there are five members, each of whom has been elected manager. The ruling holds that an LLC organized under the CLLCA possesses the corporate characteristics of limited liability and centralized management, but lacks free transferability and continuity of life. The LLC is therefore classified as a partnership. The ruling relies on the express language of the statute, rather than on any provision of the operating agreement of the LLC under consideration.
Rev. Rul. 93-6 rules, not surprisingly, that an LLC organized under the CLLCA will possess the corporate characteristics of limited liability. The ruling stems from the fact that, in general, all LLC members are shielded from the LLC's liabilities.(fn14)
In both Rev. Ruls. 88-76 and 93-5 (released on the same day as Rev. Rul. 93-6), the LLCs were managed by elected managers and three of twenty-five members were managers. In each ruling, the LLC was held to possess the corporate characteristics of centralized management. In neither case was this finding necessary for the holding of the ruling.
Both rulings present a question of whether centralized management is present as a result of the ratio of members to managers (12 percent)(fn15) or whether any organization that is managed by managers rather than members will possess centralized management. In Rev. Rul. 93-6, all the members are elected managers. Thus, it is clear that if the percentage of the LLC owned by managers were the relevant test, the LLC should lack centralized management. Nevertheless, the ruling holds as follows:
Although all of M's members are elected managers of M, M nevertheless possesses centralized management, because, as provided by the Act, authority to make management decisions rests solely with the five members in their capacity as managers rather than as members.
This language suggests that a Colorado LLC will always possess centralized management because Colorado requires that LLCs have managers.(fn16) One of the principal revisions that the Revision Committee is considering is a change allowing Colorado LLCs to be managed by members.
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