On October 21, 2021, the Internal Revenue Service (the “IRS”) released Notice 2021-56 (the “Notice”), which sets forth the additional requirements a limited liability company (“LLC”) must satisfy to obtain a determination letter recognizing its tax-exempt status under sections 501(a) and 501(c)(3) of the Internal Revenue Code.[1]

The Notice also requests public comments by February 6, 2022 to assist the IRS and Department of the Treasury in determining whether further guidance is needed. Of particular interest are potential conflicts with state LLC statutes. For instance, the Notice requests comments on whether an LLC could be formed for exclusively charitable purposes in states that require LLCs to be profit-seeking, and whether other provisions of state LLC statutes could prevent an LLC from qualifying for federal tax exemption. In addition, the Notice asks whether an LLC seeking section 501(c)(3) status should be allowed to have members that are not themselves section 501(c)(3) organizations, governmental units, or wholly-owned instrumentalities of governmental units.

While the IRS has provided informal guidance in the 2000 and 2001 Exempt Organizations Continuing Professional Education articles, the Notice represents the first formal guidance from the IRS for LLCs seeking to qualify for federal tax exemption.

Very generally, the Notice requires an LLC to add language to both its articles of organization and operating agreement that demonstrates an entirely tax-exempt purpose. More specifically, to obtain a favorable determination letter from the IRS, the Notice requires the following standards to be met by an LLC that submits a Form 1023 (“Application for Recognition of Exemption Under section 501(c)(3) of the Internal Revenue Code”) after October 21, 2021:

A. Provisions required in LLC articles of organization and operating agreement*

  1. Provision 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 a wholly-owned instrumentality of such a governmental unit);
  2. Express charitable purpose and charitable dissolution provision in compliance with Treas. Reg. §1.501(c)(3)-1(b)(1) and (4);
  3. Express Chapter 42 compliance provisions described in section 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 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 thereof).

*Of note, the Notice provides that if an LLC is formed in a state that prohibits adding provisions to the articles of organization besides those mandated by that state’s LLC law, the above conditions are deemed to be satisfied so long as: (1) the operating agreement contains those provisions; and (2) the articles of organization and operating agreement do not contain inconsistent provisions.

B. Representation on enforceability

The LLC must represent that all provisions in its articles of organization and operating agreement are consistent with applicable state LLC law and are legally enforceable.

The Notice is helpful for LLCs seeking to qualify for federal tax exemption under sections 501(a) and 501(c)(3). However, besides the LLC’s flexibility with respect to governance, it is unclear why tax-exempt organizations would favor this vehicle over the traditional corporation. Further to this point, in the Notice, the IRS requests public comments on the advantages and disadvantages of forming an entirely charitable organization as an LLC as opposed to a corporation or charitable trust. While the Notice may signal greater use of LLCs by tax-exempt organizations, it remains doubtful whether the Notice will lead to any significant changes in the market.

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

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Photo of Amanda H. Nussbaum Amanda H. Nussbaum

Amanda H. Nussbaum is the chair of the Firm’s Tax Department as well as a member of the Private Funds Group. Her practice concentrates on planning for and the structuring of domestic and international private investment funds, including venture capital, buyout, real estate…

Amanda H. Nussbaum is the chair of the Firm’s Tax Department as well as a member of the Private Funds Group. Her practice concentrates on planning for and the structuring of domestic and international private investment funds, including venture capital, buyout, real estate and hedge funds, as well as advising those funds on investment activities and operational issues. She also represents many types of investors, including tax-exempt and non-U.S. investors, with their investments in private investment funds. Business partners through our clients’ biggest challenges, Amanda is a part of the Firm’s cross-disciplinary, cross-jurisdictional Coronavirus Response Team helping to shape the guidance and next steps for clients impacted by the pandemic.

Amanda has significant experience structuring taxable and tax-free mergers and acquisitions, real estate transactions and stock and debt offerings. She also counsels both sports teams and sports leagues with a broad range of tax issues.

In addition, Amanda advises not-for-profit clients on matters such as applying for and maintaining exemption from federal income tax, minimizing unrelated business taxable income, structuring joint ventures and partnerships with taxable entities and using exempt and for-profit subsidiaries.

Amanda has co-authored with Howard Lefkowitz and Steven Devaney the New York Limited Liability Company Forms and Practice Manual, which is published by Data Trace Publishing Co.

Photo of Stuart Rosow Stuart Rosow

Stuart Rosow is a partner in the Tax Department and a leader of the transactional tax team. He concentrates on the taxation of complex business and investment transactions. His practice includes representation of publicly traded and privately held corporations, financial institutions, operating international…

Stuart Rosow is a partner in the Tax Department and a leader of the transactional tax team. He concentrates on the taxation of complex business and investment transactions. His practice includes representation of publicly traded and privately held corporations, financial institutions, operating international and domestic joint ventures, and investment partnerships, health care providers, charities and other tax-exempt entities and individuals.

For corporations, Stuart has been involved in both taxable and tax-free mergers and acquisitions. His contributions to the projects include not only structuring the overall transaction to ensure the parties’ desired tax results, but also planning for the operation of the business before and after the transaction to maximize the tax savings available. For financial institutions, Stuart has participated in structuring and negotiating loans and equity investments in a wide variety of domestic and international businesses. Often organized as joint ventures, these transactions offer tax opportunities and present pitfalls involving issues related to the nature of the financing, the use of derivations and cross-border complications. In addition, he has advised clients on real estate financing vehicles, including REITs and REMICs, and other structured finance products, including conduits and securitizations.

Stuart’s work on joint ventures and partnerships has involved the structuring and negotiating of a wide range of transactions, including deals in the health care field involving both taxable and tax-exempt entities and business combinations between U.S. and foreign companies. He has also advised financial institutions and buyout funds on a variety of investments in partnerships, including operating businesses, as well as office buildings and other real estate. In addition, Stuart has represented large partnerships, including publicly traded entities, on a variety of income tax matters, including insuring retention of tax status as a partnership; structuring public offerings; and the tax aspects of mergers and acquisitions among partnership entities.

Also actively involved in the health care field, Stuart has structured mergers, acquisitions and joint ventures for business corporations, including publicly traded hospital corporations, as well as tax-exempt entities. This work has led to further involvement with tax-exempt entities, both publicly supported entities and private foundations. A significant portion of the representation of these entities has involved representation before the Internal Revenue Service on tax audits and requests for private letter rulings and technical advice.

Stuart also provides regular advice to corporations, a number of families and individuals. This advice consists of helping to structure private tax-advantaged investments; tax planning; and representation before the Internal Revenue Service and local tax authorities on tax examinations.

A frequent lecturer at CLE programs, Stuart is also an adjunct faculty member of the Columbia Law School where he currently teaches Partnership Taxation.

Photo of Rita N. Halabi Rita N. Halabi

Rita Halabi is an associate in the Tax Department. She advises public, private and governmental entities on a variety of U.S. federal corporate, international and partnership tax matters, including mergers and acquisitions, cross-border private equity and investment fund transactions, preferred equity investments, structured…

Rita Halabi is an associate in the Tax Department. She advises public, private and governmental entities on a variety of U.S. federal corporate, international and partnership tax matters, including mergers and acquisitions, cross-border private equity and investment fund transactions, preferred equity investments, structured finance and fund finance transactions, restructurings and bankruptcy-related transactions, capital markets transactions and tax controversy.

Rita is devoted to thought leadership on tax-related topics. She is a contributing author to “International Tax Disputes: Arbitration, Mediation, and Dispute Management”, an international tax treatise published by Edward Elgar Publishing. Rita was recently the keynote speaker at a New York State Bar Association Tax Section event and participated in a private funds panel at an American Bar Association Tax Section conference. She serves on the leadership team of the American Bar Association Tax Section’s Investment Management Committee. In addition, Rita regularly blogs about developments in U.S. federal tax law on the Proskauer Tax Talks blog.