Massachusetts AG Raises Concerns About Tax-Exempt LLCs

March 14, 2022

Christopher A. Hyde
Ward L. Thomas
Office of Associate Chief Counsel
Internal Revenue Service
CC:PA:LPD:PR (Notice 2021-56), Room 5203
P.O. Box 7604, Ben Franklin Station
Washington, D.C. 20044

Re: Request for Comments on Notice 2021-56, Standards for Section 501(c)(3) Status of Limited Liability Companies

Dear Attorneys Hyde and Thomas:

We appreciate this opportunity to comment on the Department of the Treasury (Treasury Department) and Internal Revenue Service (IRS) standards for granting tax exempt status under section 501(a) of the Internal Revenue Code and as described in section 501(c)(3) to entities formed under a state's limited liability company (LLC) statute (the LLC Standards), as they are laid out in Notice 2021-56. It is our understanding based on this notice that the LLC Standards therein are those that the IRS is already applying to applications for exempt status from LLCs.

The Non-Profit Organizations/Public Charities Division (Charities Division) of the Office of the Massachusetts Attorney General (AGO) is charged with fulfilling the AGO's common-law and statutory oversight obligations with regard to charitable assets and is a member of the National Association of State Charities Officials (NASCO), which operates in affiliation with the National Association of Attorneys General (NAAG). Because of the state-level differences in charities law and corporate law acknowledged in Notice 2021-56, we limit our comments to the laws of the Commonwealth of Massachusetts.

I. Relevant State Statutes

In Massachusetts, most charitable entities that have a corporate (as opposed to a trust) form have been organized pursuant to our nonprofit corporations statute,¹ Our statute authorizing LLCs, enacted in 1995, is used much less frequently to create charitable entities.² Unlike in the traditional corporate context, in which there is one statutory scheme for business corporations,³ and a separate statutory scheme for nonprofit corporations, the Massachusetts LLC statute makes no such distinctions, permitting the formation of an LLC to “carry on any lawful business, trade, profession, purpose or activity.” Thus, while there is no prohibition on using the LLC statute to create a charitable entity in Massachusetts, there is also not a separate statute that governs the creation of nonprofit LLCs.⁴

II. Attorney General Oversight Over Charitable LLC Assets

The corporate form of a public charity —  or the lack thereof — is not determinative of the authority of the AGO over that charity's assets and activities. Under Massachusetts law, a public charity may be a nonprofit corporation, an entity formed under an instrument of trust, and even an unincorporated association. The definition therefore includes both “public charities” and “private foundations,” as those terms are used by the IRS. It would also include any LLC that has declared charitable purposes, or whose activities are charitable in nature.

In addition to benefiting from a more expansive definition of “public charity,” the AGO, through the Charities Division, endeavors to play a role that is supportive of the charitable sector in Massachusetts, which represents a significant portion of the economic activity in the Commonwealth. The Charities Division benefits from an open and ongoing dialogue with this important sector, as well as with the counsel who represent these entities. Through a combination of our legal authority and dialogue with the sector, we receive informal notice of a variety of actions being contemplated by public charities — above and beyond the formal notice requirements that may exist in our nonprofit corporations statute.

So as we consider the potential impact of having additional public charities operating in Massachusetts that have status as both (i) an LLC formed under Massachusetts law, and (ii) Section 501(c)(3) tax-exempt status, from the IRS, we conclude as an initial matter that such entities would be subject to the AGO's common-law oversight, and would also be required to register and submit annual financial filings to the Charities Division under the same statutory provisions that apply to other public charities in Massachusetts.⁵ There is also good reason to believe, based on past and current experience, that Massachusetts public charities — including those formed as LLCs — will continue to provide the Charities Division with informal notice of certain actions, including fundamental transactions that impact the control or life cycle of a public charity, even where no formal notice is required by statute or otherwise.

III. Notification of Asset Transfers and Dissolutions of LLCs

There are, however, certain provisions that are contained in our nonprofit corporations statute that place affirmative obligations on charitable entities formed under that chapter — which is the vast majority of charitable entities operating in Massachusetts — and that establish additional, more formal, reporting requirements to the Charities Division. The two areas in which this is most notable are: (i) with regard to the conveyance (though sale, transfer, or otherwise) of “all or substantially all” of a public charity's assets,⁶ and (ii) with regard to dissolutions of public charities.⁷ These provisions are not replicated in the Massachusetts LLC statute. Because of that, the Charities Division could reasonably expect to receive fewer of these formal “life cycle” types of notices from charitable entities that elect to form under the LLC statute — because they simply are not required by that statute. Those diminished regulatory reporting requirements — without more — may be an incentive for charitable entities to elect to form as an LLC, and give the Charities Division reason for concern.

Both classes of formal reporting — conveyance of assets, and dissolutions — have significant value to the oversight of charitable assets in Massachusetts. The required reporting of these events helps to buttress the informal communications the Charities Division receives with regard to even broader categories of fundamental transactions that public charities may be planning to undertake. Through these communications, the AGO can better fulfill its role in seeing to the due application of charitable assets in the Commonwealth.

In addition, on the issue of dissolutions of charitable entities, there are additional layers of concern. Under the Massachusetts nonprofit corporations statute, there is a very specific process laid out in statute to accomplish dissolution of a charitable corporation — one that involves judicial review and approval when there are remaining assets in a dissolving charity, and which always includes the AGO as a party.⁸ Under charities law in Massachusetts, the court will oversee and authorize the transfer of remaining assets to another public charity, under principles of cy pres that ensure that charitable assets remain committed to their charitable purposes.

The dissolution provisions of the Massachusetts LLC statute, however, are much more flexible,⁹ and permit a significant degree of autonomy in the members of the LLC to effect a dissolution. There is also no requirement of reporting to the AGO, because the LLC statute does not specifically address charitable assets. In addition, when considering the even more essential question of where assets are to be distributed upon dissolution — and for what purpose the LLC statute's provisions about distributions to members does not, by itself, go far enough to protect the charitable nature of assets that might be held by an LLC. This is an issue that is of paramount importance to the AGO, and which we know also to be of importance to the IRS when reviewing determination requests.

Under the statutory section on allowable distributions,¹⁰ distributions may be made to any members of the LLC, which may include natural persons, “in the manner provided for in the operating agreement” of the LLC.¹¹ This raises two separate issues — one involving potential personal inurement, and a second involving decreased transparency in charitable oversight. We know both issues to be of importance to the AGO and the IRS.

In Massachusetts, under case law that is specific to the Commonwealth, but that is grounded in general principles of charities law, a transfer by a charitable entity of a large part of its assets — without receiving fair market value for those assets — must be presented to the court for review and approval.¹² This case law applies without regard to the form of the charity. The Charities Division has published guidelines on the requirements established in the Beede case, including recommendations on when public charities should provide notice of such proposed transfers to the AGO.¹³ Those guidelines indicate that public charities should inform the Charities Division of such transfers. And while Beede guidelines do not address directly the issue of dissolutions, it is clear that the dissolution of a charitable LLC should require the same informal notice that is contemplated for other transfers of charitable assets — and that transfer of assets upon LLC dissolution will, without question, require notice pursuant to the AGO's Beede guidelines. But the state LLC statute, because it does not address the operations of charitable entities, does not address any such notice to the Charities Division.

IV. Recommendation

In light of the areas of concern we have identified here, we recommend that (i) the IRS continue to require that any member of a tax-exempt LLC be a section 501(c)(3) organization, governmental unit, or wholly-owned instrumentality of a governmental unit; and (ii) the IRS notify tax-exempt LLCs that they should consult state law to determine, among other things, whether they (a) have obligations to file operating agreements and other information with state officials and (b) have obligations to notify state officials of any member distribution or intent to dissolve.

Please do not hesitate to reach out if you have any questions.

Jonathan C. Green
Deputy Division Chief
Non-Profit Organizations/Public Charities Division
Health Care and Fair Competition Bureau
617-963-2919
jonathan.green@mass.gov