Can an LLC be a nonprofit? It depends. The limited liability companies (LLC) designation is typically used for companies that turn a profit and pay taxes on their net revenue. However, in some cases, it is possible for an LLC designation to be applied to a nonprofit company.
The nonprofit designation comes with benefits, such as tax-exempt status. But LLCs are not usually formed as nonprofit organizations. People and organizations interested in operating under a nonprofit banner typically find it much less complex to form a nonprofit corporation than forming an LLC that is to be a nonprofit entity.
But there are situations where operating under a nonprofit status as an LLC can be beneficial. If you would like to start a nonprofit in New York, The New York LLC lawyers at Lawyer For Business are ready to sit down and discuss your options.
What Is a Nonprofit LLC?
Understanding nonprofit LLCs begins with understanding the basics of LLCs and nonprofits. An LLC is a limited liability company that offers personal liability protection for the company's owners. LLCs also offer significant tax benefits, such as pass-through taxation.
A nonprofit is an organization whose purpose for being does not include generating profits. Additionally, revenue and profits earned by a nonprofit organization do not get distributed to the members, owners, or directors of the organization.
Given the two definitions detailed above, a nonprofit limited liability company would simply be an LLC that exists for purposes other than to make profits for its members. And because of specific rules governing tax exemption and LLC ownership, a nonprofit LLC may only be owned by a single organization that is tax exempt for IRS purposes.
Can an LLC Get Tax-Exempt Status (501(c)(3))?
The 501(c)(3) tax-exempt status is an extremely beneficial designation for companies in the charity world but not in the world of business. It allows organizations to avoid a federal tax exemption that excuses them from paying federal corporate income taxes.
Once this exemption is obtained at the federal level, it will typically apply at the state and local levels of taxation as well.
So can an LLC be a 501(c)(3)? It is uncommon for a for-profit business entity to seek this particular tax-exempt designation. Instead, nonprofit LLCs are usually used by already existing nonprofit corporations that are interested in creating a tax-exempt subsidiary.
When going this route, a nonprofit corporation has the option of joining forces with other nonprofit corporations to form a nonprofit limited liability corporation. However, individuals and any other organization without a tax-exempt status may not be members of a nonprofit LLC, even if the organization is a nonprofit.
Generally speaking, a nonprofit LLC may be granted tax-exempt status when one of the following applies:
- There is a single member, and that member is already a 501(c)(3) organization;
- Two or more 501(c)(3) form the LLC;
- Tax-exempt status is conferred through the filing of IRS Form 1023.
These requirements exist because the Internal Revenue Service (IRS) wants to prevent individuals or groups from enriching themselves while operating under the banner of 501(c)(3) tax exemption.
IRS Requirements to Form a 501(c)(3) Nonprofit LLC
The IRS will ultimately decide whether you receive tax-exempt status or not. To be successful, you must comply with the following twelve rules. Additionally, as mentioned, the members of your LLC must already be tax-exempt organizations. You must also stay up to date on IRS rules, such as the Limited Liability as Exempt Organization Update.
The twelve requirements are:
- 1. Create organizational documents that contain statements that limit the LLC to exempt objectives;
- 2. Have language in your organizational documents that explicitly states that the LLC operates exclusively for the charitable purposes of the LLC's members;
- 3. Have organizational language requiring members to be 501(c)(3) organizations or eligible governmental organizations;
- 4. Have organizational language that prohibits LLC membership transfer to a non-eligible group or organization;
- 5. Have organizational language requiring the transfer of interests or assets to nonmembers that are not 501(c)(3) organizations;
- 6. Have organizational language stating that the assets devoted to charitable purposes will continue as such;
- 7. Have organizational language that requires LLC article amendments to be made in accordance with section 501(c)(3) requirements;
- 8. Have organizational language that prevents the LLC from becoming or merging with a for-profit entity;
- 9. Have organizational language prohibiting the distribution of assets to former LLC members that are no longer 501(c)(3) organizations;
- 10. Have organizational language addressing situations where one or more members of the LLC ceases to be a 501(c)(3) organization;
- 11. Have organizational language stating that LLC members will enforce all legal rights and pursue all legal remedies to protect the LLC membership interests;
- 12. Have provisions in organizing documents that are consistent with the LLC laws of your state and are legally and equitably enforceable.
Once you can say that you have met the above-listed requirements, the IRS may then grant you tax-exempt status under section 501(c)(3). Because of the complexities involved in this process, hiring an experienced business attorney to handle things is essential to success.
Need Help with 501(c)(3) Tax-Exempt Status?
Alternative Business Structures with Charitable Purposes
The requirements for forming a nonprofit LLC that is 501(c)(3) tax-exempt are involved and complex. Additionally, not all organizations with charitable goals can qualify. If this is the case with your group, you should know that there are other business structures that may be beneficial for your objectives besides an LLC with 501(c)(3) tax exemption.
Low-Profit LLC (L3C)
A low-profit LLC is a relatively new type of LLC that is recognized only in a handful of states and that offers a mix of nonprofit social benefits and profit-making benefits. It does not enjoy tax-exempt status and is typically treated as a disregarded entity during tax time.
In order to qualify as a low-profit LLC you must meet the following three requirements:
- You must have a charitable or educational purpose for existence as determined by section 170(c)(2)(b) of the Internal Revenue Code;
- Your organization must be dedicated to something other than the pursuit of income or property appreciation;
- Your organization must not have purposes that are political or legislative in nature.
As mentioned, only a few states currently recognize the validity of L3C entities. They are Illinois, Maine, Michigan, Louisiana, Rhode Island, Utah, Vermont, and Wyoming.
You may also choose to form a nonprofit corporation if an LLC is not appropriate for your needs. A nonprofit corporation enjoys many of the same benefits that nonprofit LLCs enjoy. In fact, they are practically identical in most material aspects.
The only principal differences between the two are found in management and ownership. LLCs can choose their management structure, whereas nonprofit corporations are managed by boards of directors.
Additionally, nonprofit LLCs that have achieved tax-exempt status under section 501(c)(3) must have members or owners who also enjoy tax exemption. However, this is not the case for nonprofit corporations.
What Is the Best Structure for New York Nonprofits?
In New York, it is not possible to form a nonprofit LLC. Instead, nonprofits must choose the nonprofit corporation route to tax exemption. At Lawyer For Business, our nonprofit lawyers are ready to help you determine the most optimal method of achieving your goals.
Get All of Your Questions Answered by Lawyer For Business!
The way you structure your organization will have a big impact on your success. The nonprofit LLC is an option in some states for groups working in the nonprofit sector. However, in New York, you are limited to forming a nonprofit corporation to acquire tax exemption.
At Lawyer For Business, we are business lawyers with extensive experience in New York State. We are ready to help turn your visions into reality. Contact us for help sifting through the various issues that may apply to your business — let us help you create the future you desire.
Contact Lawyer For Business for help with all aspects of your 501(c)(3) tax-exempt status.
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