Guidance issued for LLCs seeking tax-exempt recognition

By Dave Strausfeld, J.D.

The IRS on Thursday issued Notice 2021-56 to clarify the standards that a limited liability company (LLC) must satisfy to receive a determination letter recognizing it as tax-exempt under Sec. 501(c)(3). Generally, all the members of an LLC seeking tax-exempt status will have to be tax-exempt organizations themselves or governmental units. The LLC will also have to include specified language in its articles of organization and operating agreement.

The notice requests public comments on these standards as well as roughly a dozen specific issues relating to tax-exempt status for LLCs, to help Treasury and the IRS decide whether further guidance is needed concerning the requirements that an LLC must satisfy to be exempt from taxation.

No previous formal guidance has been issued addressing the standards for recognition of LLCs as Sec. 501(c)(3) organizations. Relevant IRS regulations do not specifically address LLCs because they were issued in 1959, prior to the enactment of the first LLC statute in the United States, the notice notes.

Notice 2021-56 does not affect the status of organizations currently recognized as tax-exempt under Sec. 501(c)(3).

Requirements LLCs must satisfy

In Notice 2021-56, the IRS says it will issue a favorable determination letter to an LLC that submits Form 1023, Application for Recognition of Exemption Under Section 501(c)(3) of the Internal Revenue Code, after Oct. 21, only if — in addition to the general requirements under Sec. 501(c)(3) — the LLC satisfies the requirements that are set forth in the notice.

Broadly speaking, the notice's requirements are intended to ensure that the LLC is organized and operated exclusively for exempt purposes, including that its assets are dedicated to an exempt purpose and do not benefit private interests. More specifically, an LLC is required to include the following language in both its articles of organization and its operating agreement:

  1. Provisions requiring that each member of the LLC be either an organization described in Sec. 501(c)(3) and exempt from taxation under Sec. 501(a) or a governmental unit described in Sec. 170(c)(1) (or a wholly owned instrumentality of such a governmental unit);
  2. Express charitable purposes and charitable dissolution provisions in compliance with Regs. Secs. 1.501(c)(3)-1(b)(1) and (4);
  3. The express Chapter 42 compliance provisions described in Sec. 508(e)(1), if the LLC is a private foundation; and
  4. An acceptable contingency plan (such as suspension of its membership rights until a member regains recognition of its Sec. 501(c)(3) status) in the event that one or more members cease to be Sec. 501(c)(3) organizations or governmental units (or wholly owned instrumentalities thereof).

The rules are slightly different if an LLC is formed in a state whose LLC law restricts the ability to add such provisions to the articles of organization. In that case, these requirements will generally be deemed satisfied if the LLC's operating agreement includes the required provisions, so long as the articles of organization and operating agreement do not include any inconsistent provisions, the notice says.

Request for public comment

Treasury and the IRS are also seeking public comment to assist them in determining whether additional guidance is needed concerning the standards that an LLC must satisfy to be exempt from taxation under Sec. 501(c)(3). Of the dozen or so detailed questions on which public comment is sought, many relate to whether provisions of individual states' laws might affect the ability of an LLC formed in a particular state to qualify for tax exemption under Sec. 501(c)(3).

Dave Strausfeld, J.D., (David.Strausfeld@aicpa-cima.com) is a JofA senior editor.

SPONSORED REPORT

Get your clients ready for tax season

Upon its enactment in March, the American Rescue Plan Act (ARPA) introduced many new tax changes, some of which retroactively affected 2020 returns. Making the right moves now can help you mitigate any surprises heading into 2022.

100th ANNIVERSARY

Black CPA Centennial, 1921–2021

With 2021 marking the 100th anniversary of the first Black licensed CPA in the United States, a yearlong campaign kicked off to recognize the nation’s Black CPAs and encourage greater progress in diversity, inclusion, and equity in the CPA profession.