By Mike Masci
Mike Masci, CDC Fellow Fall 2022
Yes, but proceed with caution! Because Limited Liability Companies (LLCs) are a relatively new entity type, with all 50 states having adopted LLC statutes by 1996i, the Internal Revenue Service (IRS) has recently issued guidance regarding how an LLC can receive non-profit status under Section 501(c)(3) of the Internal Revenue Code.ii In this notice, the IRS outlined the requirements that the LLC must satisfy to qualify as tax-exempt for IRS purposes.
First, the entity must be organized and operated exclusively for exempt purposes and its assets are dedicated to an exempt purpose and do not support private interests.iii In addition, the LLC must have both of its articles of organization and operating agreement include the following provisions:
· Require each member of the LLC to be an organization described in Section 501(c)(3)
· Express charitable purposes and charitable dissolution provisions
· Express Chapter 42 compliance with provisions of Section 508(8)(e)(1) if the LLC is a private foundation
· Contingency plans in the vent that one or more members cease to be a Section 501(c)(3) organizationiv
The IRS has noted that some state LLC laws may restrict the types of provisions that can be included in the articles of incorporation. In this case, the requirements set forth above will meet if the (1) operating agreement contains the required provisions and (2) articles of incorporation do not contain contradictory provisions.v In addition, 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. vi
Finally, the organization files Form 1023 with the IRS along with the required provisions of the articles of organization and operating agreement, and then IRS will supply the entity with a determination letter stating they have received non-profit status.vii
Section 501(c)(3) of the Internal Revenue Code has been used since 1969 for entities to organize as non-profit companiesviii but this was before the IRS recognized LLCs as an entity type in 1997ix. Since the Internal Revenue Code was written before the IRS recognized LLCs as their own entity structure, there are potential issues and considerations one must consider before choosing to become a non-profit LLC. In addition, the guidance regarding LLC tax-exempt status has not been fully fleshed out due to LLCs being a creation of state law and tax-exempt status being a federal law. The IRS has mentioned some potential issues that may arise, but there is currently no clear resolution:
· Most states’ LLC statutes specify that an LLC may be formed for any lawful purpose. In a few states, however, the LLC statute appears to require that an LLC be a profit-seeking enterprise.
· Are there any other provisions of the LLC law in one or more states that may affect the ability of an LLC to qualify under section 501(c)(3)?
· Most state LLC laws include default provisions granting the members of LLC certain economic rights that would be inconsistent with IRC Section 501(c)(3) if the members are “private shareholders or individuals” within the meaning of IRC Section 1.501(a) – 1(c).x
Massachusetts will classify an LLC for tax purposes the same way they are for federal income tax purposes.xi This means that after the entity has received its IRS determination letter, a copy must be filed with the Corporate Division of Massachusetts Department of Revenue and once the letter has been filed, there will be no subsequent Massachusetts income tax.xii
Although the non-profit LLC will receive no Federal or Massachusetts income tax, it is still important to consider other tax implications. In 2009 the Massachusetts Supreme Judicial courts heard the case of CFM Buckley/North, LLC v. Board of Assessors of Greenfield, where it held that LLCs do not qualify for the charitable exemption from local real and personal property taxes.xiii This is because to qualify as a “charitable organization” for the purposes of receiving an exemption from real and personal property taxes, the organization must be “incorporated”.xiv Pursuant to M.G.L. c. 156c, section 2(2), LLCs are defined specifically as “unincorporated organizations formed under c. 156c and having 1 or more members.”xv This in turn means that any non-profit LLCs in Massachusetts will be responsible for all of their real and personal property taxes, which can amount to a significant tax liability.
Although the IRS and Massachusetts Department of Revenue allow for LLCs to be exempt from income taxes, one must proceed with caution because the real and property tax liability can become substantial. In addition, there is a lack of case law involving non-profit LLCs, so it can be difficult to determine how a court will rule.
i Larry E. Ribstein, LLCs: Is the Future Here? A History and Prognosis, 13 A.B.A 10, 10-13 (2003).
ii In 2021, the IRS issued Notice 2021-56 to explain the requirements an LLC must meet to qualify for an exemption from income taxes.
iii I.R.C. § 501(c)(3). iv I.R.S. Notice 2021-56.
vii Form 1023: Limited Liability Companies Eligible for Exemption, I.R.S. (Oct. 05, 2022), https://www.irs.gov/charities-non-profits/form-1023-limited-liability-companies-eligible-for-exemption.
viii A Brief History of Nonprofit Organizations (And What We Can Learn), NONPROFIT HUB, https://nonprofithub.org/a-brief-history-of-nonprofit-organizations/ (last visited Nov. 29, 2022).
ix Sandra Feldman, Understanding LLC Law: Its Past and its present, WOLTERS KLUWER (Sep. 30, 2021), https://www.wolterskluwer.com/en/expert-insights/understanding-llc-law-its-past-and-its-present
x I.R.S. Notice 2021-56.
xi Limited Liability Companies and Limited Liability Partnerships, MASS. DEP. OF REV. (Oct. 21, 2022, 5:00 PM), https://www.mass.gov/service-details/limited-liability-companies-and-limited-liability-partnerships.
xii Stephen Fishman, How to Form a Massachusetts Nonprofit Corporation, NOLO, https://www.nolo.com/legal-encyclopedia/forming-nonprofit-corporation-massachusetts-36069.html#:~:text=Once%20your%20corporation%20has%20its,your%20nonprofit’s%20IRS%20exemption%20letter (last visited Nov. 29, 2022).
xiii CFM Buckley/N., LLC v. Bd. of Assessors of Greenfield, 902 N.E.2d 381, 387 (2009).
xiv Id. at 383-384.
xv Id. at 384.