On October 21, 2021, the Internal Revenue Service (IRS) released Notice 2021-56, which clarifies the requirements for a limited liability company (LLC) to receive a determination letter that it is tax exempt under 26 USC Sections 501(a) and 501(c)(3).
Formerly, an IRS notice explained that an LLC may be tax exempt, effectively, by using the 501(c)(3) tax-exempt status of its sole member. This work-around was only possible if the member was the LLC’s sole member and had received a determination letter from the IRS recognizing its status as a 501(c)(3) tax-exempt entity. Additionally, it meant that the LLC did not receive a determination letter.
In contrast, here the IRS explains that an LLC may receive a favorable determination letter recognizing it as tax exempt under Section 501(c)(3) of the code. As explained in Section 3 of the notice, the determination remains dependent on the tax-exempt status of the LLC’s member, or members, and the LLC submitting a Form 1023, Application for Recognition of Exemption Under 501(c)(3) of the Internal Revenue Code, and is further conditioned upon certain language being included in the LLC’s articles of incorporation and operating agreement (subject to an exception where state law conflicts). The articles of incorporation and operating agreement must each include:
- Provisions requiring that each member of the LLC be either (i) an organization described in section 501(c)(3) and exempt from taxation under section 501(a) or (ii) a governmental unit described in section 170(c)(1) (or wholly owned instrumentality of this type of governmental unit)
- Express charitable purposes and charitable dissolution provisions in compliance with Sections 1.501(c)(3)-1(b)(1) and (4)
- Express Chapter 42 compliance provisions described in section 508(e)(1), if the LLC is a private foundation
- An acceptable contingency plan (such as suspension of its membership rights until a member regains recognition of its Section 501(c)(3) status) in the event that one or more members cease to be Section 501(c)(3) organizations or governmental units (or wholly owned instrumentalities of those entities)
Furthermore, the provisions must be consistent with the LLC laws of the state in which the LLC is created. Where state LLC laws prohibit additions to the standard articles of organization, the LLC may include the required language in its operating agreement only.
The remainder of the notice elaborates on potential conflicts with state law (such as a requirement that an LLC be a profit-seeking enterprise, a default law that grants LLC members economic rights, and a rule prohibiting a statement of purpose in articles of incorporation) and sets forth questions for public comment.
Public comments may be submitted electronically at www.regulations.gov via the Federal eRulemaking Portal or by mail (as set forth in the notice) by February 6, 2022. From the public comments, the IRS and Department of the Treasury (Treasury Department) will decide whether additional guidance is necessary to clarify the requirements.
If you have any questions regarding the content of this alert, please contact Sharon Brown, Public Finance Practice Area co-chair, at slbrown@barclaydamon.com; Carolyn Trespasz, associate, at ctrespasz@barclaydamon.com; or another member of the firm’s Public Finance, Corporate, or Tax Practice Areas.