IRS Issues Guidance On Requirements For Limited Liability Companies To Qualify As Tax-Exempt Entities Proskauer – Non-profit / exempt organizations
On October 21, 2021, the Internal Revenue Service (the âIRSâ) issued Notice 2021-56 (the âNoticeâ), which sets out additional requirements that a limited liability company (âLLCâ must satisfy to obtain a letter of determination recognizing its tax exempt status under sections 501 (a) and 501 (c) (3) of the Internal Revenue Code.
The notice also invites public comment by February 6, 2022 to help the IRS and the Treasury Department determine if further guidance is needed. Of particular interest are the potential conflicts with the LLC state’s statutes. For example, the notice asks for comment on whether an LLC could be formed for exclusively charitable purposes in states that require LLCs to be for-profit, and whether other provisions of the LLC’s statutes might prevent an LLC to benefit from a federal tax exemption. Further, the notice asks whether an LLC seeking Section 501 (c) (3) status should be allowed to have members who are not themselves Section 501 (c) (3) organizations. ), government units or bodies wholly owned by government units. .
While the IRS provided informal guidance in Articles 2000 and 2001 on continuing professional development for exempt organizations, the Notice represents the IRS’s first formal guidance for LLCs seeking federal tax exemption.
Very generally, the Notice requires an LLC to add wording to its articles of association and operating agreement demonstrating a fully tax-exempt objective. Specifically, to obtain a favorable letter of determination from the IRS, the notice requires that the following standards be met by an LLC that submits a Form 1023 (“Request for Recognition of Exemption under Section 501 (c) (3) of the Internal Revenue Code â) after October 21, 2021:
A. Provisions Required in the Articles and Operating Agreement of LLC *
- Provision requiring that each member of the LLC be (i) an organization described in Section 501 (c) (3) and exempt from tax under Section 501 (a); or (ii) a government unit described in Section 170 (c) (1) (or an organization wholly owned by such government unit);
- Express a charitable purpose and a charitable dissolution provision in accordance with Treas. Reg. Â§1.501 (c) (3) -1 (b) (1) and (4);
- Express the Chapter 42 compliance provisions described in Section 508 (e) (1), if the LLC is a private foundation; and
- An acceptable contingency plan (such as suspension of membership rights until a member regains recognition of their status under section 501 (c) (3)) in the event that one or more several members would cease to be 501 (c) (3) organizations or government units (or instruments wholly owned by them).
* It should be noted that the notice provides that if an LLC is formed in a state that prohibits adding provisions to the articles of the organization in addition to those mandated by the LLC law of that state, the above conditions are deemed to be fulfilled as long as: (1) the operating agreement contains these provisions; and (2) the articles of association and the operating agreement do not contain conflicting provisions.
B. Representation on enforceability
The LLC must declare that all provisions of its Articles of Association and Operating Agreement comply with applicable LLC state law and are legally enforceable.
The Notice is useful for LLCs seeking federal tax exemption under sections 501 (a) and 501 (c) (3). However, aside from the LLC’s flexibility in governance, it is not clear why tax-exempt organizations would favor this vehicle over the traditional corporation. Further to this point, in the notice, the IRS is seeking public comment on the pros and cons of forming a fully charitable organization as an LLC as opposed to a corporation or charitable trust. While the Notice may signal greater use of LLCs by tax-exempt organizations, it remains doubtful that the Notice will result in any significant changes in the market.
 All references to the “section” are to the Internal Revenue Code of 1986, as amended.