When expanding the operations of their non-profits, existing non-profit corporations may consider adding higher risk assets to subsidiary LLCs. These LLCs exist under the umbrella of the already qualified 501(c)(3) non-profit corporation. Although LLCs are unable to benefit from tax-exempt status as isolated entities if owned by anything other than a 501(c)(3) qualified non-profit corporation due to IRS regulations, separate LLCs can serve as valuable asset protection vehicles for 501(c)(3) qualified entities when they are structured as subsidiaries owned by the non-profit.
What Are the Main Differences Between Non-Profit and For-Profit Corporations?
The primary difference that separates for-profit entities and non-stock corporations in regard to acquiring tax-exempt status is their legal structures. On one hand, traditional for-profit entities can pay out profits and pay big salaries limited only by their managers’ legal and contractual duties to the business and the owners. On the other hand, non-profit entities can only pay reasonable compensation to directors and officers. They may choose between re-circulating profits back into the corporation or making grants authorized by the board of directors.
Why Should You Consider Forming a Non-Profit LLC?
A common function of subsidiary non-profit LLCs is to serve as land-holding entities for their parent corporations. Land often carries with it substantial liability.
Take the example of a non-profit rowing club operating a boathouse on contaminated land. The club may hold the property under a subsidiary LLC to insulate the club from any potential superfund liability. Similarly, A non-profit youth organization could use a subsidiary LLC for the purchase of a new plot of land for a playground.
How to Form a Non-Profit LLC
Despite differences in structure and tax status, it’s possible to combine the benefits of a non-profit corporation with the asset protections of an LLC. In order to achieve this, the non-profit board forms an LLC as a qualified subsidiary. (Learn more about subsidiary companies.)
In this parent-child relationship, the non-profit corporation serves as the sole member of the LLC. The two entities would also share the same officers and board of directors. The subsidiary LLC is a disregarded entity (DRE) for tax purposes. All of its income appears on the 990 tax return of its parent non-profit corporation, without the need for a separate return.
How Does a Non-Profit LLC Work?
Once formed, the subsidiary LLC is capable of holding assets of the non-profit corporation. The LLC as a qualified subsidiary of a non-profit does not have free reign to operate however it pleases. It is important that the purpose of the subsidiary LLC is not a substantial departure from the purpose clause established in the certificate of incorporation of the parent non-profit corporation. Additionally, under the terms of its operating agreement, the LLC cannot violate the bylaws or restrictions of its parent corporation on its face. A non-profit subsidiary LLC can only engage in activity the parent corporation permits that is substantially related to its stated purpose.
Although a non-profit subsidiary LLC must abide by this framework, there is still room for growth. The board of a non-profit corporation has the power to expand the scope of its stated purpose in order to accommodate the activity of its subsidiary LLCs. We refer to these incremental changes as “mission creep”. It is a common occurrence amongst non-profit organizations that are opportunistic and entrepreneurial. Most well-run non-profits do not etch their purposes in stone.
The non-profit subsidiary LLC is a prime example of the versatility that makes the LLC one of the most popular entities amongst businesses of all purposes and sizes.