N.Y. PARTNERSHIP THAT CONVERTED TO REGISTERED LIMITED LIABILITY PARTNERSHIP WILL BE A PARTNERSHIP FOR TAX PURPOSES.

Rev. Rul. 95-55

ISSUES

(1) Is PRS, a New York general partnership that registers as a New York registered limited liability partnership (RLLP), classified for federal tax purposes as an association or as a partnership under section 7701 of the Internal Revenue Code?

(2) Does PRS terminate under section 708(b) as a result of its registration as an RLLP? FACTS

PRS is organized as a general partnership pursuant to the provisions of the New York Partnership Law (Law), N.Y. Partnership Law sections 1 to 121-1503 (McKinney 1988 & Supp. 1994). PRS provides professional services within the State of New York. PRS registered as an RLLP, effective August 1, 1995. Each partner's total percentage interest in the partnership's profits, losses, and capital remained the same after the registration as an RLLP. The business of PRS continued to be carried on after its registration as an RLLP.

Section 121-1500(a) of the Law provides that a partnership without limited partners that meets the requirements of section 121- 1500 may register as an RLLP by filing with the New York Department of State a registration that sets forth specified information.

Section 121-1500(d) provides that a partnership without limited partners is registered as an RLLP at the time of the payment of the required fee and the filing of the completed registration with the New York Department of State or at the later date, if any, specified in the registration, not to exceed 60 days from the date of the filing. Section 121-1500(d) of the Law also provides that a partnership without limited partners that has registered as an RLLP is for all purposes the same entity that existed before the registration and continues to be a partnership without limited partners under the laws of the State of New York.

Section 26(b) of the Law provides that, except as provided by section 26(c) and section 26(d), no partner of a partnership that is an RLLP is liable or accountable, directly or indirectly (including by way of indemnification, contribution or otherwise), for any debts, obligations, or liabilities of, or chargeable to, the RLLP or each other, whether arising in tort, contract or otherwise, that are incurred, created or assumed by the partnership while the partnership is an RLLP, solely by reason of being a partner or acting (or omitting to act) in a partner capacity or rendering professional services or otherwise participating (as an employee, consultant, contractor, or otherwise) in the conduct of the other business or activities of the RLLP.

Section 26(c) of the Law provides that, notwithstanding the provisions of section 26(b), each partner, employee, or agent of a partnership that is an RLLP is personally and fully liable and accountable for any negligent or wrongful act or misconduct committed by the partner, employee, or agent or by any person under the partner's, employee's, or agent's direct supervision and control while rendering professional services on behalf of the RLLP.

Section 26(d) of the Law provides that, notwithstanding the provisions of section 26(b), all or specified partners of a partnership that is an RLLP may be liable in their capacity as partners for all or specified debts, obligations, or liabilities of an RLLP to the extent at least a majority of the partners have agreed unless otherwise provided in any agreement between the partners. The partners of PRS have no agreement that any of its partners will be liable for all or specified debts, obligations, or liabilities of PRS.

Section 62 of the Law provides in part that an RLLP is dissolved (1) without violation of the agreement between the partners by the express will of any partner when no definite term or particular undertaking is specified or (2) in contravention of the agreement between the partners, when the circumstances do not permit a dissolution under any other provision of section 62, by the express will of any partner at any time.

Section 20 of the Law provides that every partner is an agent of the partnership for the purpose of its business, and the act of every partner, including the execution in the partnership name of any instrument, for apparently carrying on in the usual way the business of the partnership of which the partner is a member binds the partnership.

Section 40 of the Law provides that no person can become a member of a partnership without the consent of all the partners.

LAW AND ANALYSIS

ISSUE (1): 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 that 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 sections 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 existcentralization of management, continuity of life, free transferability of interests, and limited liability.

Section 301.7701-2(a)(3) provides that if an unincorporated organization has more corporate characteristics than noncorporate characteristics, it is 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, PRS has associates and an objective to carry on business and divide the gains therefrom. Therefore, PRS must be classified as either a partnership or an association. PRS 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.

Certain provisions of section 301.7701-2 contain special rules that apply to partnerships subject to a statute corresponding to the Uniform Partnership Act (UPA). A partnership that registers as an RLLP under section 121-1500 of the Law is not subject to a statute that corresponds to the UPA for purposes of section 301.7701-2 because, unlike members of a UPA partnership, the members of an RLLP are not liable for any debts, obligations, or liabilities of the RLLP. Accordingly, whether PRS is classified as a partnership or an association taxable as a corporation must be determined under the general rules of section 301.7701-2.

Section 301.7701-2(b)(3) provides that an agreement establishing an organization may provide that the organization is to continue for a stated period or until the completion of a stated undertaking or such agreement may provide for the termination of the organization at will or otherwise. In determining whether any member has the power of dissolution, it will be necessary to examine the agreement and to ascertain the effect of the agreement under the local law. For example, if an agreement provides that an organization can be terminated by the will of any member, it is clear that the organization lacks continuity of life. However, if the agreement provides that the organization is to continue for a stated period or until the completion of a stated transaction, the organization has continuity of life if the effect of the agreement is that no member has the power to dissolve the organization in contravention of the agreement. Nevertheless, if, notwithstanding the agreement, any member has the power under local law to dissolve the organization, the organization lacks continuity of life.

Under the Law, an RLLP is dissolved (1) without violation of the agreement between the partners by the express will of any partner when no definite term or particular undertaking is specified in the agreement or (2) in contravention of the agreement between the partners, where the circumstances do not permit a dissolution under any other provision of the Law, by the express will of any partner at any time. Therefore, PRS 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 any group of persons that does not include all the members) has continuing exclusive authority to make the 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 continuity 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 some authority to make the decisions. For example, in the case of a corporation or a trust, the concentration of management poser in a board of directors or trustees effectively prevents stockholder or a trust beneficiary, simply because that person is a stockholder or beneficiary, from binding the corporation or the trust. However, because of the mutual agency relationship between members of a general partnership, the general partnership cannot achieve effective concentration of management powers and, therefore, centralized management.

Under the Law, every partner is an agent of the partnership for the purpose of its business, and the act of every partner, including the execution in the partnership name of any instrument, for apparently carrying on in the usual way the business of the partnership of which the partner is a member, binds the partnership. Therefore, PRS lacks the corporate characteristic of centralization of 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 partners of an RLLP are not liable for the RLLP's debts, obligations, or liabilities except for the following: (1) each partner is liable for any negligent or wrongful act or misconduct committed by that partner or by any person under that partner's direct supervision and control while rendering services on behalf of the RLLP, and (2) all or specified partners may be liable for all or specified debts, obligations or liabilities of the RLLP to the extent at least a majority of the partners have agreed unless otherwise provided in any agreement between the partners. The partners of PRS have not agreed to be liable for any of PRS's debts, obligations, or liabilities. Therefore, PRS 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 partner 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, no person can become a partner in an RLLP without the consent of all the partners. Therefore, PRS lacks the corporate characteristic of free tranferability of interests. PRS has associates and an objective to carry on business and divide the gains therefrom. In addition, PRS possesses the corporate characteristic of limited liability. PRS does not, however, possess the corporate characteristics of continuity of life, centralized management, and free transferability of interests. Accordingly, PRS is classified as a partnership for federal tax purposes.

ISSUE (2): Section 708(a) provides that a partnership is considered as continuing if it is not terminated.

Section 708(b) provides that a partnership is considered terminated only if either (1) no part of any business, financial operation, or venture of the partnership continues to be carried on by any of its partners in a partnership, or (2) within a 12 month period there is a sale or exchange of 50 percent or more of the total interest in partnership capital and profits.

Section 721 provides that no gain or loss is recognized to a partnership or to any of its partners in the case of a contribution of property to the partnership in exchange for an interest in the partnership.

Rev. Rul. 84-52, 1984-1 C.B. 157, considers the federal income tax consequences of the conversion of a general partnership into a limited partnership. Each partner's total percentage interest in the partnership's profits, losses, and capital remained the same after the conversion. Furthermore, the business of the general partnership continued to be carried on after the conversion. The revenue ruling treats the conversion as an exchange under section 721 of the Code. Because the business of the general partnership will continue after the conversion and because, under section 1.708-1(b)(1)(ii) of the Income Tax Regulations, a transaction governed by section 721 is not treated as a sale or exchange for purposes of section 708, the revenue ruling concludes that the general partnership is not terminated under section 708(b). See Rev. Rul. 95-37, 1995-17 I.R.B. 10 (the conversion of an interest in a domestic partnership into an interest in a domestic limited liability company that is classified as a partnership).

Section 446(e) provides that, except as otherwise expressly provided in chapter 1, a taxpayer who changes the method of accounting on the basis of which it regularly computes its income in keeping its books shall, before computing its taxable income under the new method, secure the consent of the Secretary.

The registration of PRS as an RLLP is treated as a partnership- to-partnership conversion that is subject to the principles of Rev. Rul. 84-52. Therefore, PRS will not terminate under section 708(b) as a result of its registration as an RLLP, and PRS must continue to use the same methods of accounting used before its registration as an RLLP.

HOLDINGS

(1) PRS has associates and an objective to carry on business and divide the gains therefrom, but lacks a preponderance of the four remaining corporate characteristics. Accordingly, PRS a New York general partnership registered as a New York RLLP is classified as a partnership for federal tax purposes.

(2) PRS will not terminate under section 708(b) as a result of its registration as an RLLP.

DRAFTING INFORMATION

The principal author of this revenue ruling is Stephen J. Coleman of the Office of Assistant Chief Counsel (Passthroughs & Special Industries). For further information regarding this revenue ruling contact Stephen J. Coleman on (202) 622-3060 (not a toll-free call).