The IRS has issued Notice 2021-56 outlining the requirements that LLCs seeking 501(c)(3) status must meet to be recognized as tax-exempt by the IRS. These requirements apply to LLCs that file Form 1023 after October 21, 2021.
A corporation or other body designated in Code Sec. 501(c)(3) must generally meet the organizational and operational tests to be recognized as tax-exempt. These requirements state that the business must be created and operated solely for charitable or other tax-exempt purposes, with no part of the entity’s net earnings going to any private shareholder or individual.
The organizational test requirement was in place before the first LLC Act was enacted in the United States. As a result, the Treasury Regulations do not address how LLCs can meet the organizational requirement outlined in Treasury Regulation § 1.501(c)(3)-1(b).
Required Provisions for LLCs Seeking 501(c)(3) Status
According to the Notice, the IRS will issue a determination letter to an LLC seeking 501(c)(3) status only if both the LLC’s articles of organization and its operating agreement include the following provisions:
- Provisions requiring that each member of the LLC be either:
- an organization described in section 501(c)(3) and exempt from taxation under section 501(a); or
- a governmental unit described in section 170(c)(1) (or wholly-owned instrumentality of such a governmental unit).
- Provisions describing the charitable purposes and ensuring the assets will be used for charitable purposes upon dissolution in compliance with Treasury Regulation § 1.501(c)(3)-1(b)(1) and (4).
- If the LLC is a private foundation, the governing documents must include the express chapter 42 compliance provisions described in § 508(e)(1).
- An acceptable contingency plan if one of its members ceases to qualify as § 501(c)(3) organizations or governmental units such as suspension of membership rights.
Representation on Enforceability
The LLC must certify that all elements of its articles of organization and operating agreement are legal and enforceable under applicable state LLC law.
States with Limitations on Articles Provisions
The Notice clarifies that if an LLC is formed under a state LLC law that prohibits the addition of required provisions to the articles of organization. In such cases, the Notice requirements will be satisfied if the LLC’s operating agreement includes the necessary provisions and the LLC’s governing documents do not include any inconsistent provisions.
Request for comments.
The IRS is seeking feedback on the standards outlined in Section 3 of the Notice and other specific issues. By February 6, 2022, written comments can be sent via the Federal eRulemaking Portal at regulations.gov (enter IRS-2020-0042 in the search area on the regulations.gov homepage to access Notice 2021-56 and submit comments).
The Notice will provide welcome guidance to nonprofits that create subsidiary or affiliated LLCs and want to obtain tax-exempt status for them.
Ellis Carter is a nonprofit lawyer with Caritas Law Group, P.C. Ellis advises nonprofit and socially responsible businesses on corporate, tax, and fundraising regulations. Ellis is licensed to practice in Washington and Arizona and advises nonprofits on federal tax and fundraising regulations nationwide. Ellis also advises donors with regard to major gifts. To schedule a consultation with Ellis, call 602-456-0071 or email us through our contact form.