IRS Allows Charitable Contributions To Disregarded Entities

In Notice 2012-52,1 the IRS announced that taxpayers may make tax deductible contributions to domestic single-member limited liability companies (SMLLCs) wholly owned by U.S. charities. If all other requirements of section 170 are satisfied, the IRS will treat a contribution to an SMLLC that (i) is created under the laws of the United States, a U.S. state or possession, or the District of Columbia and (ii) is wholly owned and controlled by a U.S. charity, as a charitable contribution for purposes of the deduction provided in section 170(a). Under the entity classification regulations, the SMLLC is treated as a branch or division of its parent and referred to as a disregarded entity.2 Notice 2012-52 is effective for charitable contributions made on or after July 31, and provides for retroactive application to any years for which the statute of limitations remains open.

The notice also treats the U.S. charity that owns the SMLLC as the donee organization for purposes of the substantiation and disclosure requirements of sections 170(f) and 6115 (donee acknowledgement letters, quid pro quo contribution disclosures, etc.). In Notice 2012-52 the IRS urges charities to disclose in acknowledgement letters or other statements that the SMLLC is wholly owned by the U.S. charity and treated by the U.S. charity as a disregarded entity, to avoid "unnecessary inquiries by the Service". The notice ends the uncertainty that has existed since the 1997 effective date of the check-the-box regulations over whether the IRS would treat charitable contributions to disregarded entities owned by charities as deductible contributions — at least in the domestic context.3

1. ISSUES THE NOTICE DOES NOT ADDRESS

   Notice 2012-52 does not address deductibility for gift and estate tax purposes. Nor does it mention the treatment of contributions to foreign disregarded entities owned by domestic charitable organizations (which may raise additional concerns for the IRS). However, it does not suggest that different principles would apply for gift and estate tax purposes and does not foreclose the possibility of deductions for charitable contributions to foreign disregarded entities owned and controlled by domestic charities.

   1. Limited to domestic SMLLCs? The guidance in the notice is limited to confirming the deductibility of contributions to domestic SMLLCs that are owned and controlled by domestic charities. The limited discussion in the notice of the entity classification regulations and section 170 contains no suggestion that similar treatment should not apply to any domestic or foreign disregarded entities appropriately controlled by a domestic charity. For example, a contribution to a domestic limited partnership 100 percent owned, directly or indirectly, by a domestic charity in which the charity holds the general partner interest (and possibly also the limited partner interest) through one or more SMLLCs, should be within the scope of the notice, as should a contribution to a domestic unincorporated association controlled by a domestic charity.4 The treatment of contributions to foreign disregarded entities owned by domestic charities is discussed below.

   2. Gift and estate tax deductibility. Notice 2012-52 is silent on the deductibility for gift and estate tax purposes of gifts to disregarded entities owned by charities. For purposes of the estate tax imposed by section 2001, the value of a decedent's taxable estate is determined, in part, by deducting from the value of the gross estate the amount of all bequests, legacies, and transfers to or for the use of any charity.5 A similar deduction is allowed for purposes of the gift tax imposed by section 2501 on lifetime transfers by gift.6 However, the notice does not foreclose the possibility that the same analysis and conclusions regarding the deductibility of gifts to disregarded entities owned by charities for income tax purposes would also apply to deductibility for estate and gift tax purposes.

2. WHY CHARITIES USE DISREGARDED ENTITIES

   1. Domestic disregarded entities. Charities use disregarded entities for various reasons, including to limit liability in connection with specific projects, activities, or assets. Although a charity in theory could directly receive charitable contributions and then fund an LLC or other entity to carry on a particular activity or project, to shield the rest of the organization from any prospective liabilities, there are situations — for example, donations of real estate — when the charity will want to have the LLC receive the contribution to avoid entering the chain of title (for example, to limit exposure to environmental claims). Charities also form LLCs for special projects, and some charities want those LLCs to raise funds on their own in support of the projects. Commentators have noted that an LLC may hold some assets that a section 501(c)(2) title holding organization7 may not and is not required to apply for recognition of tax-exempt status or file an information return (at least in the domestic context).8

   2. Foreign disregarded entities. In the foreign context, a U.S. charity may want to have a locally organized affiliate to operate in compliance with local laws or to open a bank account in another jurisdiction. A U.S. charity could always accept contributions and then transmit the funds to a foreign subsidiary, if it maintains control over the foreign subsidiary's operations.9 However, the charity may have the same concerns regarding the chain of title for donated real property that it would have in the domestic context or the same desire to have a local entity to conduct a project. Also, in the case of charities that receive substantial donations from dual residents — for example, a charity that conducts substantial operations in a foreign country and receives donations from U.S. citizens who also are tax residents in the foreign country — a local charitable entity (that could check the box to be disregarded for U.S. tax purposes) may be needed for U.S. donors to receive charitable contribution deductions in both countries. Although foreign taxes paid by the donors generally may be credited for U.S. income tax purposes, the absence of a deduction in either the foreign country or the United States could undo the benefit of the deduction in the other country. In a report on the deductibility of charitable contributions to...