Nonprofit Organizations vs. LLCs: Understanding the Differences

A nonprofit organization can overlap with a limited liability company (LLC). Understanding the differences between the two can help owners make informed financial decisions and overcome challenges.

Depending on where you are located, there may be advantages to forming a corporation or nonprofit.  For example, Buffalo, NY, has a unique business landscape and favorable economic factors. Companies that choose the right entity type can identify cost-saving opportunities and solve common business problems in their city or town.

Each entity type faces its own unique taxation, funding options, and operational efficiencies. Consider these differences between LLCs and nonprofits and how an attorney for non-profit organizations can provide valuable insights into both.

What Is a Non-Profit Organization?

A non-profit organization is a legal entity formed for a specific charitable, educational, artistic, or social cause. The organization is not formed to generate profits or engage in political activity. Instead, the goal of non-profits is to address societal needs, foster positive change, and provide public benefits.

Some examples of non-profit organizations include:

• Foundations that support scientific research
• Charities that run symphony orchestras and art museums
• Educational institutions
• Advocacy groups, like the American Cancer Society

Non-profit organizations are exempt from income tax. They can generate revenue but not profit.

What Is an LLC (Limited Liability Company)?

An LLC is a flexible business structure combining the limited liability protection of a corporation with lower taxation. An LLC can even be a non-profit under certain circumstances.

In most cases, LLCs are for-profit businesses. Owners often choose these structures because the only assets at risk for the company's liabilities are the owner's investments. The owners' personal assets are protected.

LLC owners can elect pass-through taxation, avoiding the double taxation of corporations. An LLC business lawyer often recommends this structure for small businesses, startups, real estate ventures, and professional services.

Delving into the Dissimilarities: Nonprofits vs. LLCs

Understanding how nonprofits and LLCs differ is crucial to limiting your financial and legal exposure. Consider this table comparing them to help you make informed decisions based on your company's needs:

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Nonprofit corporations operate, report, and get taxed differently than LLCs. Choosing the right legal entity has financial and legal implications. Contact an attorney from Lawyer For Business to discuss options for your business organization.

This table summarizes the differences between these entity types. To learn more, read on.

1. Legal Structure and Formation

Understanding the legal implications and obligations of each structure is critical. Both LLCs and nonprofit corporations are legal entities with a separate legal existence from the people who run them.

You form a nonprofit corporation by filing articles of incorporation with the state. You also file a list of the nonprofit's board of directors. After formation, a lawyer drafts the corporate bylaws to govern its operation and apply for tax-exempt status under federal and state law.

To form an LLC, you file articles of organization with the state. The articles list the initial owners or members. The company's lawyer prepares the LLC's operating agreement that will govern its operation.

2. Ownership and Control

Ownership is one of the most significant differences between LLCs and nonprofits.

Nonprofit corporations have no shareholders and as a result, no owners. They are controlled by a board of directors that acts according to the nonprofit's corporate bylaws and its mission statement.

LLCs are owned by the members. LLCs are either member-managed or manager-managed. The management structure determines who makes day-to-day decisions for the company. But even if you choose to vest operational control in managers, all the members will vote on certain important issues, like adding new members.

3. Taxation, Tax-Exempt Status, and Financial Considerations

Taxation is one of the critically important differences between LLCs and nonprofits. A business lawyer can also explain the financial advantages of each structure and ensure compliance with tax laws.

A defining characteristic of nonprofits is their tax-exempt status. Since nonprofits carry out a charitable purpose, they get federal tax exemptions. They cannot generate profit — only revenue. For example, a charity in Buffalo, NY, can sell custom graphic t-shirts and market them to its loyal football team fan base to raise money. Excess revenue goes back into the charity.

LLCs are not tax-exempt organizations. Instead, they generate revenue and pay state and federal taxes on their profits. LLCs can elect how they are treated for tax purposes.  Navigating tax exemption requires advanced skill and knowledge, and using an attorney can help ensure proper procedures are followed.  

4. Fundraising and Financing

Funding opportunities available to an LLC or a nonprofit differ. A business lawyer can guide entities through the fundraising and fundraising processes.

Nonprofits rely on two sources of fundraising. They can solicit donations, grants, and sponsorships. When a nonprofit obtains its federal tax exemption, it also gets permission to accept tax-deductible contributions. Thus, donors receive tax benefits by donating to charitable organizations. A lawyer can help ensure compliance with tax laws when a nonprofit accepts donations.

LLCs can raise capital through member contributions. They can take out loans from banks or investors. A business lawyer can help LLCs make informed decisions about each of these options.

5. Governance and Reporting Requirements

LLCs and nonprofits operate differently. A business lawyer can help create effective and compliant governance practices.

A nonprofit is run by its board of directors. The directors usually set goals and appoint officers to manage the day-to-day operations. A lawyer may be needed to navigate the very high compliance and reporting requirements imposed on nonprofits due to their tax exemptions.

Major decisions in an LLC are made by the members. Day-to-day operations may be handled by managers or members. LLCs have lower compliance and reporting requirements than nonprofits. A lawyer can ensure adherence to LLC regulations and help to avoid penalties or legal problems.

6. Liability and Risk Management

Liability protection is a critical issue when selecting an entity. You need to know whether owners or members become liable for the company's debts and liabilities.

Both nonprofit entities and LLCs provide personal liability protection. Nonprofits have no owners, and LLCs were specifically created to provide limited liability for members.

For example, suppose an LLC or a nonprofit orders $1 million in goods. The nonprofit plans to sell the goods as a fundraiser. The LLC is a retailer that resells the goods at a profit. In both cases, the entity is responsible for paying for the goods. Members and board members will not become personally liable for the company's debts.

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7. Social Impact and Mission Alignment

When comparing an LLC vs. a nonprofit, keep in mind that it’s not only nonprofits that can make a social impact. All entities can have a socially beneficial purpose. But an LLC's primary mission is business-oriented, while a nonprofit's is charitable.

For LLCs, social impact is secondary to its business. Thus, an LLC might donate 10% of sales to breast cancer research. But its first objective is to make sales. A nonprofit, on the other hand, must have a social impact, or it risks losing its tax exemptions. Both entity types can benefit from legal advice to uphold their social values and fulfill their missions.

8. Decision-Making and Flexibility

Decision-making covers two aspects of entity operations. You want to know whether the entity can make a decision and if so, who makes that decision.

LLCs can make almost any type of decision and use almost any type of decision-making structure. It is one of the most flexible and adaptable entity types. In contrast, nonprofits are highly regulated. They have limitations on both the decisions they can make and how they can make them.

In either case, legal representation may be needed to create a decision-making procedure that complies with the law, offers scalability, ensures smooth operations, and allows the entity to provide a nimble response.

The Upsides and Downsides of Nonprofit Organizations

Nonprofits are highly regulated, but they can also provide significant tax advantages.

Benefits of Organizing a Nonprofit

Some benefits of a nonprofit entity include:

• Exemption from most federal and state taxes
• Positive social impact
• Mission-driven approach
• Community involvement

Nonprofit structures are designed to improve society through cultural, educational, scientific, and charitable works.

Disadvantages of Organizing a Nonprofit

Some disadvantages of a nonprofit entity include:

• The need to file tax returns to maintain high levels of financial transparency
• Limitations on funding models and revenue streams
• Reliance on donations
• High administrative burdens to ensure compliance

In some situations, these disadvantages can even impact a nonprofit's ability to operate smoothly or achieve its goals.

Compared to LLCs, nonprofits provide significant advantages in taxation. They can also focus on social change rather than profits. But administrators spend a lot of time on compliance.

The Upsides and Downsides of LLCs

LLCs are highly flexible and can be organized for almost any business purpose.

Benefits of Starting an LLC

The benefits of LLCs include:

• Personal liability protection
• Flexibility in the operating agreement to set up the management structure
• Power to elect its tax treatment by the IRS
• Ease of formation

These benefits are particularly suited for small businesses and entrepreneurs.

Disadvantages of Starting an LLC

Disadvantages of LLCs include:

• Self-employment taxes and income taxes on undistributed revenue if members elect pass-through taxation
• The difficulty of adding members to raise capital through equity
• Lenders potentially requiring personal guarantees from members
• Unwieldy management structure as members increase

You can mitigate some of these disadvantages by incorporating as an S or C corporation or becoming a nonprofit entity. Nonprofits, for example, are exempt from most taxes and have a simple management structure.

Seek Guidance: Engage a Lawyer for Your Non-Profit or LLC

Both LLCs and nonprofits require strict compliance with state and federal law to form correctly. They provide distinct benefits and drawbacks. Most importantly, they are suited for different purposes. Understanding each will help you choose the right entity structure for your purpose.

Lawyer For Business is a law firm with extensive knowledge and experience in forming new entities for both charitable and business purposes. A business lawyer can provide tailored guidance about your situation that you cannot get online or from a book. Contact us to discuss your needs today.