Philanthropists often ask about forming non-profit LLCs, otherwise commonly referred to as 501c3. Due to IRS regulations, LLCs are not able to be assigned tax-exempt status directly. A 501c3 is a coveted designation because it exempts a company from federal taxes, sales taxes, and property taxes. This can be incredibly helpful to a nonprofit. You may form a non-profit corporation and operate an LLC wholly owned by said corporation.
Non-Profit Corporations (501c3s) vs. LLCs
The reason why LLCs cannot obtain a non-profit tax exempt determination (also known as 501c3 status) is because LLCs have members who are the owners of the LLC. This is unlike a non stock corporation, which has no stockholders.
The only way to use an LLC to hold assets for a Non-Profit Corporation is to have the LLC be a qualified subsidiary of the Non-Profit Corporation. To do this, the LLC’s sole member would be the Non-Profit Corporation. The LLC’s management would only be permitted to engage in activities permitted of its parent non-profit corporation. The Non-Profit corporation parent’s same directors and officers must also control the member managed single member LLC (See IRC Reg. 301.7701-3 et seq. as interpreted by Ann. 99-62 1999-43 I.R.B. 545). Thus, if you, Bob and Sue are the three directors of a non-profit corporation, you three must also manage the subsidiary LLC. You must also avoid any activities not permitted by the parent corporation.
Additionally, the LLC’s Operating Agreement must specify that the LLC cannot violate the bylaws or restrictions on its member non-profit 501c3 corporation. In other words, you cannot do something with a non-profit subsidiary LLC, an LLC controlled by a non-profit corporation, unless it is a permissible activity of the parent Non-Profit Corporation.
Using a Subsidiary Corporation for a Non Profit Corporation (501c3)
One common use of a subsidiary non-profit LLC is to hold real estate as a land-holding entity. This is especially common if the property is a brownfield with toxic contamination. That way, the Non-Profit Corporation is not in the chain of title with superfund liability.
Sometimes Non-Profits also operate public service vans and those vehicles can be titled in the name of a subsidiary LLC. For example, a breast cancer charity purchasing a mobile mammography van can set up an LLC subsidiary to take title to the van. This may provide a degree of insulation for the parent organization, should the vehicle incur uninsured liability.
At a recent meeting of the American Bar Association (ABA) Business Law’s Non-Profit Committee, one practitioner said that she would love to try to apply for tax exemption on behalf of an LLC (without a parent corporation), but the other practitioners in the room thought it would result in a legal battle with the IRS and could potentially set new precedent allowing for a Non-Profit LLC. To date, no new Non-Profit has approached her seeking a legal battle, just to become a Non-Profit LLC.
The Low-Profit LLC
Some states offer the L3C, which is a low-profit LLC. However, even these are not eligible to be 501c3 qualified and have few practical purposes. Many attorneys tell clients to avoid the L3C because it offers no advantages and only disadvantages over a traditional LLC. For example, if members of an LLC agreed to keep profits low to help other causes, that is already within their ability to do in a traditional LLC agreement. Few states have adopted L3C statutes.
How to Form a Non-Profit Corporation (501c3)
Therefore, should you wish to form a Non-Profit that is 501c3 qualified, you must first form a corporation. Next, complete IRS Form 1023 or IRS Form 1023EZ to obtain a tax determination letter from the IRS. Once you receive the letter, which can be retroactive, your donors can deduct their contributions to your company as charitable contributions on their personal tax returns. At that point, you may decide to form a subsidiary LLC to hold assets separate from the parent Non-Profit Corporation.