On July 31 2012 the Internal Revenue Service announced in Notice 2012-52 that donors may claim charitable deductions for their contributions to domestic disregarded limited liability companies (LLCs) that are wholly owned and controlled by US charities.
This guidance provides welcome comfort to donors and the charities that they support. However, the notice confirms deductibility only for contributions to domestic disregarded LLCs. The IRS remains silent on the issue with respect to disregarded entities organised under foreign law, leaving the treatment of such entities to be determined under the existing regulations.
The regulations on business entity classification under Section 7701 of the Internal Revenue Code provide that a domestic single-member LLC is presumed to be a disregarded entity unless it makes an affirmative election to be treated separately from its owner.(1) Many foreign, single-member entities are eligible for the same treatment, although in a number of cases this requires an affirmative election.(2)
The IRS first interpreted these rules in the context of exempt organisations in Announcement 99-102, confirming that if the sole member of an LLC is an organisation that is exempt from tax under Section 501(c)(3) of the code, the activities of the disregarded entity are treated as if they were conducted through a branch or division of the single owner.(3) Thus, assets owned or income received by the LLC are treated as if they were owned or received by the exempt member, and the LLC's finances and operations must be reported on the charity member's annual Form 990. Similarly, a private foundation's grant to a disregarded, single-member LLC that is wholly owned by a public charity is treated as a grant to the charity.(4)
Although prior guidance gave comfort to charities and private foundations, the IRS declined to address the deductibility of individual or corporate gifts to charity-owned LLCs. The applicable regulations treat disregarded entities - regardless of their country of organisation - as their owners for virtually all federal tax purposes, and seem equally applicable for the purposes of Section 170 as for other purposes on which the IRS has previously ruled.(5) However, the IRS's refusal to confirm this conclusion had created enough uncertainty to hinder charitable planning, particularly with respect to contributions of real property and other assets that are commonly held through special-purpose limited liability vehicles. The notice confirms that the straightforward application of the disregarded entity regulations is correct for domestic disregarded entities (ie, those created or organised under US law, as the US parent charity must be in order to receive deductible contributions). However, it continues the IRS's silence on the parallel conclusion for foreign disregarded entities. This distinction is remarkable because normally the effect of disregarding an entity is to make its parent's foreign or domestic status - rather than the entity's own status - determinative for tax purposes.(6)
For foreign disregarded entities, nothing in Notice 2012-52 alters the IRS's position of silence as to whether contributions are deductible under Section 170. On balance, the notice is good news - it is a helpful additional confirmation of deductibility in the domestic context and leaves the treatment of contributions to foreign disregarded entities to be determined under the existing regulations, as before. It remains to be seen whether the IRS will provide further guidance on contributions to foreign disregarded entities.
For further information on this topic please contact Diara Holmes, Douglas N Varley or Michael Durham at Caplin & Drysdale by telephone (+1 202 862 5000), fax (+1 202 429 3301) or email (firstname.lastname@example.org, email@example.com or firstname.lastname@example.org).
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(1) Section 301.7701-3(b)(1). See also the explanation of default rules in the instructions to IRS Form 8832 on entity classification election.
(2) See Section 301.7701-3(b)(2) of the Treasury Regulations.
(3) IRS Announcement 99-102, 1999-43 IRB 545 (October 25 1999). See also Private Letter Rulings 200134025, 200150027 and 200249014, holding that a single-member LLC owned by a charity is not required to file a separate exemption application.
(4) Information Letter 2010-52, March 15 2010.
(5) See Section 301.7701-2(c)(2) of the regulations.
(6) In comparison, see for example Section 1.1441-1(b)(2)(iii)(B) of the regulations.