IRS Releases Guidance on Requirements for Limited Liability Companies to Qualify as Tax-Exempt Entities

On October 21, 2021, the Inner Income Service (the “IRS”) launched Discover 2021-56 (the “Notice”), which units forth the extra necessities a restricted legal responsibility firm (“LLC”) should fulfill to receive a willpower letter recognizing its tax-exempt standing underneath sections 501(a) and 501(c)(3) of the Inner Income Code.[1]

The Discover additionally requests public feedback by February 6, 2022 to help the IRS and Division of the Treasury in figuring out whether or not additional steerage is required. Of specific curiosity are potential conflicts with state LLC statutes. As an example, the Discover requests feedback on whether or not an LLC may very well be fashioned for solely charitable functions in states that require LLCs to be profit-seeking, and whether or not different provisions of state LLC statutes might forestall an LLC from qualifying for federal tax exemption. As well as, the Discover asks whether or not an LLC looking for part 501(c)(3) standing ought to be allowed to have members that aren’t themselves part 501(c)(3) organizations, governmental models, or wholly-owned instrumentalities of governmental models.

Whereas the IRS has supplied casual steerage within the 2000 and 2001 Exempt Organizations Persevering with Skilled Schooling articles, the Discover represents the primary formal steerage from the IRS for LLCs looking for to qualify for federal tax exemption.

Very usually, the Discover requires an LLC to add language to each its articles of group and working settlement that demonstrates a completely tax-exempt function. Extra particularly, to receive a good willpower letter from the IRS, the Discover requires the next requirements to be met by an LLC that submits a Kind 1023 (“Application for Recognition of Exemption Under section 501(c)(3) of the Internal Revenue Code”) after October 21, 2021:

Provisions required in LLC articles of group and working settlement*

  1. Provision requiring that every member of the LLC be both (i) a corporation described in part 501(c)(3) and exempt from taxation underneath part 501(a); or (ii) a governmental unit described in part 170(c)(1) (or a wholly-owned instrumentality of such a governmental unit);

  2. Specific charitable function and charitable dissolution provision in compliance with Treas. Reg. §1.501(c)(3)-1(b)(1) and (4);

  3. Specific Chapter 42 compliance provisions described in part 508(e)(1), if the LLC is a personal basis; and

  4. A suitable contingency plan (such as suspension of its membership rights till a member regains recognition of its part 501(c)(3) standing) within the occasion that a number of members stop to be part 501(c)(3) organizations or governmental models (or wholly owned-instrumentalities thereof).

*Of notice, the Discover supplies that if an LLC is fashioned in a state that prohibits including provisions to the articles of group in addition to these mandated by that state’s LLC legislation, the above circumstances are deemed to be happy so lengthy as: (1) the working settlement incorporates these provisions; and (2) the articles of group and working settlement don’t include inconsistent provisions.

Illustration on Enforceability

The LLC should signify that every one provisions in its articles of group and working settlement are in keeping with relevant state LLC legislation and are legally enforceable.

The Discover is useful for LLCs looking for to qualify for federal tax exemption underneath sections 501(a) and 501(c)(3). Nevertheless, in addition to the LLC’s flexibility with respect to governance, it’s unclear why tax-exempt organizations would favor this car over the normal company. Additional to this level, within the Discover, the IRS requests public feedback on the benefits and drawbacks of forming a completely charitable group as an LLC as opposed to an organization or charitable belief. Whereas the Discover might sign higher use of LLCs by tax-exempt organizations, it stays uncertain whether or not the Discover will lead to any vital modifications out there.

[1] All references to “section” are to the Inner Income Code of 1986, as amended.

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