Can an LLC Be a Nonprofit?
Yes, a limited liability company (LLC) can be a nonprofit. However, forming a nonprofit limited liability company can be complex, so few people choose this option.
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.
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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 is an organization that is formed to serve the public. The focus of the nonprofit may be educational, religious, charitable, or literary, for example. Even though there are many types of nonprofits, they have one thing in common: they are not formed to make profits.
- 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.
- An LLC is a more flexible structure. With an LLC, you would still get the liability protection you would have in a corporate structure. This means that you would be protected from personal liability for business debts or obligations. However, you would have more flexibility in the way that you organize the management of the business.
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 (or other agency)
- Make corporate bylaws
- Apply for tax-exempt status
Forming a nonprofit LLC is more complicated for a few reasons. First, there could be laws in your state against forming a nonprofit LLC. For example, some states have laws saying an LLC must be formed for a business purpose. This type of rule could be a problem where a nonprofit organization was formed for a charitable purpose. LLCs are regulated by state law, so you would 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 has to do with gaining 501(c)(3) status and meeting the IRS's conditions for nonprofit limited liability companies.
Tax Exemption for Limited Liability Companies
Suppose you are interested in forming a nonprofit LLC. In that case, you'll probably 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 a federal income tax. Nonprofit corporations can qualify for tax-exempt status.
A nonprofit LLC can also 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 members, which are 501(c)(3) organizations, own the LLC, the IRS will treat the business entity as a partnership for tax purposes. This means that there will be pass-through taxation which will flow to the LLC owners. If the LLC uses Form 1023 to get recognized as a tax-exempt entity, 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 or not an LLC could get 501(c)(3) status, they decided that an LLC could qualify for the tax exemption. However, the IRS also laid out twelve 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 focus of the conditions is on making sure 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 exempt purposes. Also, the LLC can't carry on activities that are not permitted for 501(c)(3) organizations.
Many of the conditions have to do with the language in the organizational documents for the LLC. Typically, to form an LLC, you must make and file Articles of Organization.
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 many states, any organizational language is acceptable as long as it is consistent with the laws of that state.
If you are interested in forming an LLC that meets the conditions for 501(c)(3) status, you may need to include organizational language such as the following:
- The LLC's activities are limited to exempt purposes
- The LLC operates for a charitable purpose
- The members of the LLC must be 501(c)(3) organizations
- The transfer of membership interests to an organization other than a 501(c)(3) organization is not allowed
- The transfer of interests (other than membership interests) to a nonmember other than a 501(c)(3) organization can only be done for fair market value
- 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
- A plan will be followed in case one or more members are no longer 501(c)(3) organizations
- The exempt members will protect their rights and interests
- All provisions in the organizational documents are consistent with state law
If your LLC otherwise meets the requirements for a tax-exempt organization and meets the twelve conditions, then your business entity could be recognized as a nonprofit LLC.
Low-Profit Limited Liability Companies
If you're not sure 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 not yet recognized the low-profit LLC (or L3C), so you will first need to 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 nonprofits' restrictions. A low-profit LLC is not a tax-exempt entity.
Low-profit LLCs can make profits from capital investment. Private foundations have to contribute a percentage of their earnings to a charity each year. This is called 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). However, a foundation can invest in an L3C without going through this long process. This is because the requirements to form an L3C match the requirements of a PRI.
Want to Form a Business With a Charitable Purpose?
You might also find it beneficial to weigh all of your options with an experienced lawyer in your area. Don't hesitate to consult a business and commercial lawyer about your small business and the type of business entity that is right for you.
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