Chief Counsel's Office Nixes Tax Strategy Using Charitable Donation of LLC Interests

(Parker Tax Publishing February 2026)

The Chief Counsel's Office issued a field attorney advice memorandum discussing the tax implications of an investment strategy involving a transfer by taxpayers, a married couple, of nonvoting interests in a limited liability company (LLC) they formed and that earned investment income to a Code Sec. 501(c)(3) organization. The Chief Counsel's Office advised that the transfer of LLC interests was disregarded under the economic substance doctrine, the charitable organization was not a bona fide partner of the LLC, and the income from the non-voting interests purportedly transferred to the charitable organization was taxable to the taxpayers under the assignment of income doctrine. FAA 20260401F.

Background

An investment advisor devised a Strategy for a married couple (Taxpayers), to earn investment income "in a tax-free environment" and claim charitable contribution deductions. Pursuant to the Strategy, the Taxpayers formed and made capital contributions to a limited liability company (LLC) in exchange for voting and nonvoting interests in the LLC.

The LLC earned investment income. The Taxpayer-Husband was named the manager of the LLC and controlled its investment accounts and managed and controlled its operations. The Taxpayer-Husband never authorized a distribution to the Organization, and the Organization had no independent right to receive any investment income from the LLC without the Taxpayer-Husband's consent. Nor did the Organization have any right to participate in management or exercise control over its interest in the LLC. In addition, the Organization's interest was severely limited. Except under certain circumstances, the Organization could not transfer its nonvoting interest in the LLC without the Taxpayer-Husband's consent.

On the same day that the LLC was formed, the Taxpayers transferred nonvoting interests, to which they allocated a percentage of LLC's partnership items to a Code Sec. 501(c)(3) organization (Organization). The nonvoting interests were transferred to the Organization to fund a purported donor advised fund (DAF). During the tax years at issue, the Taxpayers withdrew funds from the LLC's brokerage account and took loans from the LLC's assets.

The Taxpayers claimed a charitable contribution deduction equal to the asserted appraised fair market value of the nonvoting interests transferred. The Taxpayers retained the voting interests in the LLC to which they allocated the remaining partnership items. The Taxpayers did not attach a qualified appraisal for the value of the property transferred, nor a contemporaneous written acknowledgement of the contribution, to their return for the year of the contribution.

The Chief Counsel's Office was asked to consider whether to (1) treat the LLC's investment income allocated to the Organization as taxable to the Taxpayers; (2) treat the capital accounts of the Organization as belonging to the Taxpayers; and (3) disallow the Taxpayers' charitable contribution deductions.

Law and Analysis

The Chief Counsel's; Office advised that:

(1)The transfer of nonvoting interests in the LLC to the Organization should not be respected for tax purposes because the transfer lacked economic substance.

(2)The Organization did not have sufficient economic or membership interests in the LLC to treated as a bona fide partner.

(3)The partnership income allocated to the nonvoting interests in the LLC transferred to the Organization was taxable to the Taxpayers under the assignment of income doctrine.

(4)The Taxpayers were not allowed to claim charitable contribution deductions for their transfers of interests in the LLC to the Organization.

Economic Substance

Under Code Sec. 7701(o), a transaction will be treated as having economic substance if (1) the transaction changes in a meaningful way (apart from federal income tax effects) the taxpayer's economic position; and (2) the taxpayer has a substantial purpose (apart from federal income tax effects) for entering into such transaction. The economic substance analysis requires both a subjective and an objective inquiry. The subjective factors focus on the taxpayer's expectations and motives to determine whether the transaction was engaged in for business purposes other than tax avoidance. The objective analysis focuses on whether a reasonable investor would enter into the transaction.

The Chief Counsel's Office advised that the transaction did not meaningfully change the Taxpayers' economic position (aside from tax consequences) nor did the Taxpayers have a substantial purpose in participating in the transaction (aside from tax consequences). Under the subjective analysis, the Chief Counsel's Office found that the Strategy (1) did not support the Taxpayers' stated reasons for engaging in it, (2) the Taxpayers did not follow the agreements, and (3) the Taxpayers' intention for undertaking the Strategy was solely to shield themselves from tax on substantial short-term gains.

The transaction failed the objective inquiry, according the Chief Counsel's Office, because (1) the LLC was not organized for a nontax business purpose and (2) the parties' economic position did not change as a result of the transaction. In the view of the Chief Counsel's Office, the LLC was formed primarily to allow the Taxpayers to avoid tax on their personal investments and to receive a charitable contribution deduction for those investments. In addition, the Taxpayers treated the assets of the LLC as if they were the Taxpayers' personal assets and the Taxpayer-Husband remained in control of all assets held by the LLC.

Partner Status of the Charitable Organization

The Chief Counsel's Office advised that the Organization was not a bona fide partner of the LLC because it had no meaningful stake in, and did not participate in any of the upside or downside from, the LLC. The Organization did not share in the upside, the Chief Counsel's Office found, because the Taxpayer-Husband disregarded the operating agreement and did not make the required mandatory distributions from the LLC. The Taxpayers were also able to drain the value of the LLC through purported loans, receiving the immediate benefit of a distribution. The Organization was not exposed to any downside, according the Chief Counsel's Office, because it did not pay for its membership interest and made no cash outlays to fund the LLC. Regardless of what happened to the LLC economically, the Organization remained in the same position: receiving distributions at the Taxpayer-Husband's sole discretion.

The Chief Counsel's Office further found that the Organization was not recognized as a member of the LLC for tax purposes under Code Sec. 704(e). With respect to partnerships in which capital is a material income-producing factor, Code Sec. 704(e)(1) provides that a person will be recognized as a partner for tax purposes if he owns a capital interest in such a partnership whether or not such interest is derived by purchase or gift from any other person. Reg. Sec. 1.704-1(e)(2) provides that, whether an alleged partner who is a done of a capital interest in a partnership is the real owner of such capital interest, and whether the donee has dominion and control over such interest, must be ascertained from all the facts and circumstances. Under Reg. Sec. 1.704-1(e)(2)(ii), if the donor has retained control of the partnership interest that he has purported to transfer to the done, then the donor should be treated as remaining the substantial owner of the interest. Under Reg. Sec. 1.704-1(e)(2)(ix), a donee partner may be a limited partner who does not participate in the management of the partnership if the donee partner's right to transfer his interest is not subject to substantial restriction.

The Chief Counsel's Office found that in this case, the nonvoting interests purported to have been donated to the Organization were similar to limited partnership interests as described in Reg. Sec. 1.704-1(e)(2)(ix), in that they did not confer any voting rights or any right to a say in the management and operation of the LLC. The Chief Counsel's Office noted that the Organization's lack of voting rights or control of the LLC would not be dispositive of the issue in this case. Accordingly, the Chief Counsel's Office said it was important to note, that aside from the lack of voting interests, the Organization also had no ability to realize the value allegedly associated with the nonvoting interests and the Taxpayer-Husband was able to, and did, drain value from the assets that were to provide the value allegedly donated to the Organization.

Assignment of Income

Under the assignment of income doctrine, a person anticipating receipt of income cannot avoid tax by diverting the income to another person. In order for a valid transfer of property to occur, there must be a significant change in the economic relationship of the taxpayer to the property. The assignment of doctrine income applies if the taxpayer retains rights in and control over the transferred assets.

The Chief Counsel's Office found that the Taxpayer-Husband never parted with dominion and control over the assets of the LLC. There was no change in the economic relationship of Taxpayer-Husband and the property of LLC. According to the Chief Counsel's Office, the Taxpayers created the illusion that they parted with an interest in LLC, but in reality, they only assigned the income for purposes of the Form 1065, as the Organization had no right to this income or any distributions from the partnership. The Chief Counsel's Office also found that the nonvoting interests in the LLC had no value. Thus, the Chief Counsel's Office concluded that the income from the assets of the LLC should be treated as 100 percent taxable to the Taxpayers under to the assignment of income doctrine.

Denial of Charitable Deduction

The Chief Counsel's Office advised that the Taxpayers' charitable contribution deduction should be denied because they (1) lacked charitable intent in transferring the nonvoting shares to the LLC and (2) failed to comply with the substantiation requirements for charitable donations. The Chief Counsel's Office found that the Taxpayers' predominant purpose in transferring the nonvoting LLC to the Organization was to engage in the Strategy for which they received substantial, identifiable financial benefits in return. In addition, they failed to comply with Code Sec. 170(f)(8), the Chief Counsel's Office found, because they did not attach a contemporaneous written acknowledgement of the contribution by the donee organization. They also ran afoul of the requirement in Code Sec. 170(f)(18)(B) to include a statement from the Organization that it, as the sponsoring organization of a donor advised fund, had exclusive legal control over the assets contributed.

For a discussion of the economic substance rule, see Parker Tax ¶99,730. For a discussion of capital as an income-producing factor in recognizing partner status, see Parker Tax ¶20,107. For a discussion of the assignment of income doctrine, see Parker Tax ¶70,105. For a discussion of charitable contributions from which a taxpayer expects a substantial benefit in return, see Parker Tax ¶84,110. For a discussion of substantiating an charitable contribution, see Parker Tax ¶84,190.

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