Can an LLC Be a Nonprofit?

When people refer to nonprofits, they often mean a nonprofit corporation. This is because many of the founders of nonprofits choose to incorporate. Due to the many requirements for forming a nonprofit limited liability company, it could be easier to organize your nonprofit as a corporation instead of an LLC.

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Nonprofit Corporation vs. Nonprofit LLC

What is the difference between a nonprofit corporation and a nonprofit LLC? At its core, a nonprofit serves the public. The nonprofit purpose may be educational, religious, charitable, or literary. Even though there are many types of nonprofits, they have one thing in common: they are not formed to make a profit.

A corporation and an LLC are types of business structures:

• A corporation is a more rigid structure with directors, officers, and shareholders. There are also many requirements that shareholders must keep up with to comply with state laws or tax statuses, like being an S corporation. For example, having bylaws, regular meetings, resolutions for decisions, and conflicts of interest policies and procedures.

• An LLC is a more flexible structure. With an LLC, you would still get the liability protection you would have in a corporate structure. You would be protected from personal liability for business debts or obligations. However, you would have more flexibility in organizing the business’s management.

Forming a nonprofit corporation is similar to starting other types of corporations. You would need to:

• Select a name for the corporation

• Submit articles of incorporation to the secretary of state in your state and pay a filing fee

• Assemble a board of directors

• Draft corporate bylaws

• Apply for tax-exempt status

Forming a nonprofit LLC is more complicated for a few reasons.

First, your state could have laws against forming a nonprofit LLC. For example, some states have laws that an LLC must be formed for a business purpose. A nonprofit business is not formed to make money but to promote charitable purposes and allow for fundraising.

State law regulates LLCs, so you need to find out if any state laws would prevent the formation of a nonprofit LLC in your state.

Another possible roadblock in forming a nonprofit limited liability company involves gaining 501(c)(3) tax-exempt nonprofit status. There are many IRS conditions for nonprofit limited liability companies.

Tax Exemption for Limited Liability Companies

Suppose you want to form a nonprofit LLC. In that case, you’ll want to know if your LLC could get 501(c)(3) status. 501(c)(3) status is a tax status that allows nonprofit organizations to operate without paying federal income tax. Nonprofit corporations can qualify for tax-exempt status as well.

A nonprofit LLC can qualify for tax-exempt status in three situations:

• A single member owns the LLC, which is itself a 501(c)(3) organization

• Two or more members, which are 501(c)(3) organizations, own the LLC

• The LLC gets recognition as a tax-exempt entity by filing Form 1023 with the IRS

When a single member owns the LLC, the IRS will treat the LLC as a sole proprietorship for tax purposes. When two or more LLC members that are 501(c)(3) organizations own the LLC, the IRS will treat the business entity as a partnership or association for tax purposes. This means there will be pass-through taxation, which will flow to the LLC owners.

Suppose the LLC uses Form 1023 to get recognized as a tax-exempt entity. In that case, the IRS will treat the entity as a corporation for tax purposes. The Form 1023 route also requires that the owners of the LLC be 501(c)(3) organizations.

Conditions for 501(c)(3) Status as an LLC

When the IRS considered whether an LLC could get 501(c)(3) status, it decided that it could qualify for the tax exemption. However, the IRS also laid out conditions for an LLC to be recognized under the 501(c)(3) exemption. A document called “Limited Liability Companies as Exempt Organizations-Update” contains a list of the conditions.

The conditions focus on ensuring that the nonprofit LLC meets the requirements for a 501(c)(3) organization under the Internal Revenue Code. To meet these requirements, the LLC must be organized for tax-exempt purposes. Also, the LLC can’t carry out business activities not permitted for 501(c)(3) charitable organizations.

Many of the conditions have to do with the language in the organizational documents for the LLC. To start an LLC, you must make and file articles of organization with the secretary of state. You must comply with the filing requirements in the state where the LLC operates.

Articles of organization often include the business name, a statement of purpose, registered agent information, and management information. An LLC usually has an operating agreement, as well. In some states, an LLC operating agreement is required.

To form an LLC that meets the 501(c)(3) status conditions, you must include precise organizational language in two documents. Your articles of organization and operating agreement must include:

• The LLC‘s activities are only for charitable purposes or exempt purposes as defined by IRS 501(c)(3)

• The LLC operates for a charitable purpose, any for-profit activities must be insubstantial

• Members of the LLC must be exempt

• Assets used for charitable purposes will continue to be used for charitable purposes upon dissolution of the LLC

• Any amendments to the organizational documents must be consistent with section 501(c)(3)

• The LLC can’t merge with or become a for-profit entity

• The LLC can’t distribute assets to any member who is no longer a 501(c)(3) organization

• There is a plan in case one or more members are no longer 501(c)(3) organizations

• All provisions in the organizational documents are consistent with state law

If your LLC otherwise meets the requirements for a tax-exempt organization and the IRS conditions, your business entity could gain nonprofit LLC status.

Low-Profit Limited Liability Companies

If you need more clarification about forming a nonprofit corporation or a nonprofit LLC, another option is a low-profit LLC. A low-profit LLC is a for-profit business entity with a charitable purpose. Some states have yet to recognize the low-profit LLC (or L3C), so you must first determine if you can form this business entity in your state.

Some business owners find the L3C appealing because it allows them to further a charitable purpose without worrying about nonprofit restrictions. A low-profit LLC is not a tax-exempt entity.

Low-profit LLCs can make profits from capital investment. Private foundations must contribute a percentage of their earnings to a charity each year. This is a program-related investment.

Often, there is a process that the foundations must go through to make sure that the investment they plan to make to satisfy the yearly requirement qualifies as a program-related investment (PRI).

Want To Form a Business With a Charitable Purpose?

With FindLaw’s DIY business formation service, we make forming an LLC or nonprofit corporation simple.

It is also beneficial to weigh all your options with an experienced lawyer in your area. Feel free to consult a business and commercial lawyer and an accountant about your small business and the type of business entity that is right for you.