IRS addresses LLC issues in Delaware statute and cash-basis accounting.

• Author: McKoy, Lawrence W.
• Position: Limited liability companies

The IRS recently issued Rev. Rul. 93-38 and a letter ruling that address the classification of Delaware limited liability companies (LLCs) and the cash-basis problem.

In Rev. Rul. 93-38, the Service ruled on two factual situations dealing with the Delaware Limited Liability Company Act. Unlike so-called "bullet proof" statutes that do not allow changes to the statute in areas that might affect the classification as a partnership, the Delaware law contains numerous provisions that can be modified by an LLC agreement. In this ruling, the IRS examined two factual situations involving Delaware LLCs. The Service classified the first situation as a partnership, concluding that the LLC lacked a preponderance of the corporate characteristics: 1. Continuity of life: The LLC's continuity was not assured because after the termination of a member, all remaining members would have to agree to continue the business. 2. Centralization of management: Because the LLC agreement vested the entity's management in all of its members, the corporate characteristic of centralized management was absent. 3. Limited liability: The LLC did possess the corporate characteristic of limited liability under the state LLC law. 4. Free transferability of interests: Although a member could assign or transfer an interest to a nonmember, the assignee or transferee would not become a substitute member and would not acquire all of the attributes of the member's interest unless all of the remaining members approved the assignment or transfer; thus, there was no free transferability of interests.

In the second situation, the Delaware LLC was ruled to be an "association for tax purposes." 1. Continuity of life: Pursuant to the LLC agreement, the entity would continue under all circumstances without the approval or consent of any member or manager. 2. Centralization of management: The LLC was managed by its elected managers in accordance with the LLC agreement. 3. Limited liability: Same results as in the first situation. 4. Free transferability of interest: The approval or consent of any other member or manager was not a prerequisite to an effective substitution of parties pursuant to an assignment or transfer of a member's interest to a nonmember.

Thus, in Delaware, the terms of the LLC agreement dictate the type of entity for tax purposes. Care will need to be used to avoid an unwanted tax result by careless drafting.

Cash basis accounting for LLC

In Letter Ruling 9321047, the IRS...