LLCs – Standards to Qualify for 501(c)(3)

The IRS issued Notice 2021-56, Standards for Section 501(c)(3) Status of Limited Liability Companies and has requested comments from the public.  This notice is an initial attempt by the IRS to set standards for Limited Liability Companies (“LLCs”) to become a tax-exempt organization under Internal Revenue Code (IRC) Sec. 501(c)(3), which previously was only allowed under the Treasury Regulations for entities organized as corporations or trusts. This new guidance is in line with the 2021-2022 Priority Guidance Plan (“PGP”), issued by Treasury and the IRS, which prioritizes providing guidance related to the issues most important to taxpayers.  For more information on the PGP, see the following link from CLA’s Innovation in Nonprofit Finance Blog:  IRS’s Priority Guidance Plan for Exempt Organizations | CLA (CliftonLarsonAllen) (claconnect.com)

The notice lays out the general requirements for an organization to be considered tax-exempt under Section 501(c)(3), as well as the background of entity classification.  It follows up with the reason why such a notice was needed to begin with, which is that LLCs did not exist when the original guidance under Treasury Regulation Sec. 501(c)(3)-1(b) (describing the organizational test) was issued.  Next, the IRS discusses state LLC statutes, and how they differ depending on the state.

In section 3 of Notice 2021-56, the IRS sets forth the standards for an LLC to meet to apply for tax exemption using Form 1023.  An LLC may successfully apply for tax exemption if the articles of incorporation and operating agreement both include several provisions that are applicable to corporation and trust exempt organizations, including the distribution of organization assets to other 501(c)(3) organizations upon dissolution, private foundation provisions found in Section 508(e)(1), if applicable, and other items.  The organizing documents must also include some more LLC-specific items:  provisions requiring LLC members to be 501(c)(3) or government units, as well as contingencies for situations where a member might lose its tax-exempt status.

The difficulty in these new standards lies in the fact that some state LLC laws may present obstacles to following the IRS’s standards, whether it be due to limitations on what may be included in the articles of organization, or other limitations contained in the state statutes that may prevent the LLC from meeting the requirements of Sections 501(c)(3), 508, or other parts of the Internal Revenue Code dealing with tax exemption.

The IRS is requesting comments on these standards to determine what happens in situations where an LLC attempting to qualify has non-tax-exempt members, as well as for assistance in understanding state LLC statutes and how they may impact the ability to apply for tax-exemption.  The notice can be found at N-2021-56 (irs.gov) with the full list of requested comments.

If you have any questions or comments, please reach out to CLA’s exempt organizations tax team member, Joseph Godino at Joseph.Godino@CLAconnect.com or Frank Giardini, CLA’s Principal In Charge, National Exempt Tax Practice, at Frank.Giardini@CLAconnect.com.