Limited Liability Companies can be Tax-Exempt as Title-Holding Companies.
In our May 2016 edition of Tax News, our article Nonprofit Exempt Organizations, Not Every Nonprofit Organization Can be Tax-Exempt explained how some Limited Liability Companies (LLC) (with a federal election to be an association, taxed as a corporation) may qualify to be exempt from the taxes imposed under Revenue & Taxation Code (R&TC) Section 23701. In this article, we will explain how an LLC that holds title for an organization exempt under R&TC Section 23701 may qualify for exemption from tax as a title-holding organization under R&TC Section 23701h or 23701x.
Limited liability companies (LLC) can elect to be taxed as partnerships, disregarded entities, or associations taxed as corporations.
R&TC Section 23701 permits LLCs that elect to be associations, taxed as a corporations to request exemption from income or franchise taxes imposed under Part II, Division 2, Corporation Tax. The LLC or single member limited liability companies (SMLLC) must be 100 percent owned and controlled by a tax-exempt parent organization(s).
LLCs that elect to be taxed as partnerships or as disregarded entities are generally subject to a tax and fee imposed under R&TC Sections 17941 and 17942. These sections are included within Part 10, Division 2, Personal Income Tax. Generally, if an LLC is taxed as a partnership or disregarded entity, there is no authority for the Franchise Tax Board to grant exemption from the tax and fee imposed by Sections 17941 and 17942. However, a LLC classified as a partnership or as a disregarded entity that meets all of the requirements of R&TC Section 23701h or 23701x may qualify for exemption from the tax under Part 11, and the tax and fees imposed under Chapter 10.6 (commencing with Section 17941) of Part 10.
It is important to remember that for an LLC to receive tax-exempt status under R&TC Section 23701h or 23701x, the LLC must have been organized to hold title to property and all member(s) of the LLC must be tax-exempt. The LLC or SMLLC must be 100 percent owned and controlled by parent organization(s) who has/have exemption under Internal Revenue Code (IRC) section 501(c) or 401(a).
The fundamental purpose of a title-holding company organized under R&TC Section 23701h or 23701x is to:
- Hold title to property,
- Collect income therefrom, and
- Turn over the entire amount, minus expenses, to a tax-exempt parent organization or organizations.
To qualify for exemption under R&TC Section 23701h, the LLC must be an organization described in IRC Section 501(c)(2), organized for the exclusive purpose of holding title to property, collecting income, and turning over the entire amount to an organization which itself is exempt as a (n):
- Pension plan described in IRC Section 401(a),
- Organization described in IRC Sections 501(c)(1) through 501(c)(27), or
- Religious or apostolic organization described in IRC Section 501(d).
To qualify for exemption under R&TC Section 23701x, the LLC must be an organization described in IRC Section 501(c)(25). In contrast to R&TC Section 23701h, under Section 23701x the title-holding company is restricted to acquiring and holding title to real property for its tax-exempt parent organization(s). The title-holding company can be a corporation or trust which can have up to 35 parent organizations including any combination of:
- Qualified pension, profit sharing, or stock bonus plans under IRC Section 401(a),
- Governmental pension plans under IRC Section 414(d),
- Government agencies, or subdivisions, of the United States, any state, or local government, or
- Organizations exempt under IRC Section 501(c)(3).
It is important to note that title-holding companies described in R&TC Section 23701h or Section 23701x are the only type of organizations described in R&TC Section 23701 that are not required to organize or incorporate as nonprofit. They are also the only type of organizations organized as limited liability companies that are classified as partnerships or as disregarded entities that may qualify for exemption from tax under Part 11 and exemption from the tax and fees imposed under Chapter 10.6 (commencing with Section 17941) of Part 10.
For more information about tax requirements and/or applying for tax exempt status, visit ftb.ca.gov and search for Exempt Organizations, or contact our Exempt Organizations Unit at 916.845.4171.