Can a single-member LLC that is a federally disregarded entity get its own Texas franchise-tax exemption based on its tax-exempt sole member?

Plain-English summary

A single-member LLC treated as a federally disregarded entity asked for its own franchise-tax exemption under Tax Code Sec. 171.063. The Comptroller said it does not qualify.

• The exemption needs the entity's own IRS letter. Sec. 171.063(b) exempts a corporation that is exempt under IRC Sec. 501(c), and Sec. 171.063(c) requires furnishing the Comptroller a copy of the IRS exemption letter issued to that entity.
• A disregarded entity has no letter of its own. Because the LLC is a disregarded entity - treated for federal purposes as an integral part of its sole member - it has not been granted a federal exemption of its own, so the Sec. 171.063 exemption is not possible. Texas does not grant a separate exemption to an activity, department, branch, or integral part of an exempt organization.
• So it must file. Since no franchise exemption is available, the LLC must file all franchise-tax reports with payment.
• But it can still buy tax-free. If the sole member has established its own sales-tax exemption, the LLC may make tax-free purchases in two ways: (1) as the member's agent - buying items for the member's exempt purpose and issuing the exemption certificate in the member's name; or (2) the member buys the items tax-free and transfers them to the LLC.

Currency note: The franchise analysis is under the pre-2008 franchise tax (replaced by the margin tax effective January 1, 2008 under House Bills 3 and 3928). The margin tax has its own rules for LLCs, disregarded entities, and combined reporting; confirm current law.

What this means for you

Single-member LLCs owned by a tax-exempt organization

Being owned by an exempt parent does not make the LLC exempt on its own for the franchise tax - it needed its own IRS determination letter, which a disregarded entity does not have. The practical workaround was on the sales-tax side: buy through the member, or as the member's agent for the member's exempt purpose.

Tax professionals

The letter applies the entity-specific exemption requirement of Sec. 171.063(c) and Texas's rule against exempting a mere integral part of an exempt organization. Note the split outcome: no franchise exemption, but usable sales-tax exemption purchasing via the member. Re-verify under the margin tax, which treats LLCs and disregarded entities differently.

Common questions

Q: Can a disregarded single-member LLC get its own Texas franchise-tax exemption?
A: No. It has no IRS exemption letter of its own, which Sec. 171.063(c) requires.

Q: Does it still have to file franchise-tax reports?
A: Yes. Because no exemption is available, the LLC must file all franchise-tax reports with payment.

Q: Can it buy items tax-free through its exempt member?
A: Yes - either as the member's agent (certificate in the member's name) or by having the member buy tax-free and transfer the items to the LLC.

Citations and references

Statutes:

• Texas Tax Code Sec. 171.063(b) - franchise-tax exemption for a corporation exempt under IRC Sec. 501(c) (listed subsections)
• Texas Tax Code Sec. 171.063(c) - exemption established by furnishing the Comptroller a copy of the entity's IRS exemption letter

Source

• STAR search: https://star.comptroller.texas.gov/search?doc_type_code=L&tax_type_code=FIT
• Opinion: https://star.comptroller.texas.gov/view/200106900L

Original ruling text

June 21, 2001

Dear **:

Thank you for your recent letter requesting exemption for **
(Company), Taxpayer No. **, as a disregarded entity.

You are requesting franchise tax exemption under Texas Tax Code Section
171.063. Tax Code Section 171.063(b) provides a franchise tax exemption for a
corporation exempted under Internal Revenue Code (IRC) Section 501(c)(2), (3),
(4), (5), (6), (7), (8), (10), (16), (19) or (25).

Based on the information provided, the Company does not qualify for franchise
tax exemption. Tax Code Section 171.063(c) specifies that a corporation's
exemption be established under Subsection (b) by furnishing the Comptroller
with a copy of the Internal Revenue Service letter of exemption issued to the
corporation.

For federal tax purposes, the Company is a disregarded entity and recognized as
an integral part or tax-exempt activity of its sole member. Therefore, the
Company has not been granted a federal exemption of its own, and exemption
under Tax Code Section 171.063 is not possible. Furthermore, the documentation
provided does not show the Company is established or operating as a non-profit
entity.

Under Texas law, a separate exemption is not granted to an activity,
department, branch, or integral part of an exempt organization. Consequently,
a letter of exemption cannot be issued in the Company's name for exemption from
the franchise tax or sales tax.

As a disregarded entity of a sole member that has qualified for and established
its sales tax exemption with our office, the Company may take advantage of its
relationship with the sole member in the following two ways.

The Company may make tax free purchases as an agent of the sole member. When
acting as an agent of the sole member, the items or taxable services purchased
must relate to the sole member's exempt purpose and not be used for the
personal benefit of an individual or private party. When acting as agent of,
the Company must issue the sales tax exemption certificate in the name of the
sole member.

OR

The tax-exempt sole member may issue a sales tax exemption certificate in its
own name, make tax free purchases that relate to its exempt purpose, and then
transfer the items to the Company.

Enclosed is an exemption certificate that may be issued when following either
of the two options previously mentioned. The certificate does not require a
number to be valid and may be reproduced locally.

If your organization makes any sales of taxable items or services, please
contact our Tax Assistance Section at 1-800-252-5555 to determine if a sales
tax permit is needed. The direct number is 512/463-4600.

Since an exemption from the franchise tax is not possible, the Company is
responsible for filing all franchise tax reports with appropriate payments. If
you have questions about the filing of the reports or need to obtain the report
forms, contact our Tax Assistance Section toll free at 1-800-252-1381.

If the organization changes its name, registered agent or registered office
address, it is required to notify the Secretary of State.

If you have questions about the request for exemption, you can e-mail us at
, or call me toll free at 1-800-531-5441, extension
3-4142. My direct number is 512/463-4142.

Sincerely,

Wanda K. Carter
Exempt Organizations Section