Keep a Tight Rein on Charitable LLCs, New York AG Says

March 10, 2022

Mr. Ward Thomas
Mr. Christopher Hyde
Office of the Associate Chief Counsel
Employee Benefits, Exempt Organizations and Employment Taxes
Internal Revenue Service

Re: Notice 2021-56
Comments from the Office of New York Attorney General Letitia James

Dear Mr. Thomas and Mr. Hyde:

I am writing in response to Notice 2021-56 in which the Treasury Department and the Internal Revenue Service ("IRS") request comments on the standards applicable to Limited Liability Companies ("LLCs") that seek tax-exemption pursuant to sections 501(a) and 501(c)(3) of the Internal Revenue Code ("the Code") and whether additional guidance is needed concerning LLCs' compliance with those provisions of the Code. The Notice also includes questions posed to state charity regulators, such as the New York Attorney General's Charities Bureau, "with respect to interpretation of state LLC laws, reference to other pertinent laws, and applicability of state charity laws to LLCs formed for charitable purposes (charitable LLCs)." The comments that follow respond to certain of those questions and the impact on New York's regulation of charities when LLCs are formed for charitable purposes and granted tax-exempt status pursuant to the Code. We welcome the opportunity to respond to the Notice.

Responsible management of charitable assets and entities by their fiduciaries is crucial to a strong charitable sector, which, in New York state, constitutes 18% of the state's private workforce. New York law grants the Attorney General broad responsibility for oversight of organizations that hold charitable assets and/or engage in charitable activities in our state. Charitable LLCs domiciled in other jurisdictions are subject to some of that oversight, including pursuant to the Estates, Powers and Trusts Law ("EPTL") but are likely not statutorily subject to the same oversight or fiduciary responsibilities as are charitable trusts and charitable corporations formed pursuant to the Not-for-Profit Corporation Law ("N-PCL"), or foreign corporations and their fiduciaries under Section 1319 of the N-PCL.

As the IRS noted in 2001 EO CPE Text (co-authored by Mr. Thomas), "Some states (California, Indiana, Iowa, Maryland, Minnesota, New York, North Dakota, Rhode Island, Texas, Utah, and Virginia) and the District of Columbia appear to require that an LLC be formed for a business purpose." New York limited liability companies are permitted to be organized only for and to engage in "lawful business purposes" under Section 201 of the New York Limited Liability Company Law. As set forth in Section 102(e), of that law, business "means every trade, occupation, profession or commercial activity" and so would not include an LLC organized for exclusively charitable purposes. As Such, the IRS should not recognize 501(c)(3) tatus for LLCs domiciled in New York.

We also suggest that the IRS consider requirements that where charitable LLCs are authorized by their domicile jurisdiction, they be required to include in their articles of organization and operating agreements the following provisions: (1) a prohibition on merging with a for-profit entity, (2) a prohibition on transferring any of their assets to a for-profit entity and (3) a requirement that the Charitable LLC give notice to the attorney general of the state of formation of any transaction, litigation or other circumstance to the extent that such notice is required by the state's laws governing nonprofit organizations.

As recognized in the Notice, laws governing Charitable LLCs vary from state to state and some states may not regulate them at all. Therefore, any guidance prepared by the IRS should refer the public and counsel to the need to review applicable state laws when forming and/or apply for tax exemption on behalf of a charitable LLC. Where state law, as in New York, does not authorize creation of an LLC for charitable purposes, the IRS should refuse to authorize 501(c)(3) eligibility for LLCs domiciled in that jurisdiction.

We appreciate the opportunity that Mr. Thomas gave to members of the National Association of State Charity Officials to meet virtually on January 18, 2022, with representatives of the Internal Revenue Service and the Treasury Department. We welcome the opportunity to continue our discussion of charitable LLCs and the ways in which we might work together to ensure that the needs of the nonprofit sector, and compliance with Code section 501(c)(3) and state oversight may be addressed to respond to the concerns of our agencies.

Sincerely,

Karin Kunstler Goldman
Deputy Chief, Charities Bureau