Philanthropists often ask if an LLC can be a non-profit. What they are referring to is the 501c3 tax-exemption status. 501c3 status is a coveted designation because it exempts a company from federal, sales, and property taxes. These exemptions are crucial to the function of non-profit organizations.
IRS regulations do not allow LLCs to be assigned tax-exempt status directly. However, you may operate an LLC as a wholly owned subsidiary of a non-profit corporation.
We discuss how non-profit corporations can best use LLCs to reduce their liability risk.
Non-Profit Corporations (501c3s) vs. LLCs
Non-profit corporations with tax exempt status (also known as 501c3 status) are incorporated as non-stock corporations. This is a type of legal entity that does not have any stockholders.
Traditional LLCs have beneficial owners who hold an economic interest in the company. This characteristic of LLCs makes them ineligible for obtaining 501c3 exemption status.
A non-profit corporation can still use an LLC to hold certain assets. To do this, the LLC must be a qualified subsidiary with the non-profit corporation being its sole member. The LLC’s management is permitted only to engage in activities approved by the parent non-profit corporation.
The directors and officers of the non-profit corporation must also control the member managed 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.
The LLC’s Operating Agreement must specify that the LLC cannot violate the bylaws or restrictions of its member non-profit corporation. A subsidiary LLC cannot do something unless it is a permissible activity of the parent non-profit corporation.
How To Use a Subsidiary LLC for a Non Profit Corporation (501c3)
One way non-profits use subsidiary LLCs is as land-holding entities for real estate. This is especially common if the property is a brownfield with toxic contamination. Holding the property under an LLC keeps the non-profit corporation out of the chain of title. This can protect the corporation from superfund liability.
Non-profits corporations may operate service vans or other vehicles. A non-profit can title vehicles in the name of a subsidiary LLC in order to provide a degree of insulation for the corporation.
For example, a breast cancer charity purchasing a mobile mammography van can set up an LLC subsidiary to hold title to the van. This can help protect the non-profit if the vehicle incurs any uninsured liabilities.
What Is A Low-Profit LLC?
Some states offer the L3C, which is a low-profit LLC. However, even these are not eligible for 501c3 status and have few practical purposes. Attorneys often advise clients to avoid the L3C because it only offers disadvantages compared to a traditional LLC. Members of an LLC can already agree to keep profits low in order to contribute to public benefit causes. Very few states have adopted low-profit LLC statutes.
How to Form a Non-Profit Corporation (501c3)
To create a Non-Profit that is 501c3 qualified, follow the following steps
- Form a non-stock corporation.
- Complete IRS Form 1023 or IRS Form 1023EZ to apply for recognition of tax exemption status under section 501c3.
- Obtain a tax determination letter from the IRS.
Once you receive the letter, your donors can deduct their contributions to your company as charitable contributions on their personal tax returns. Note that this can be done retroactively.
Can You Convert an LLC to a Nonprofit?
To become a non-profit in its own right, an LLC would first need to convert to a non-stock corporation. This involves the LLC members giving up their ownership interest before converting to remain eligible for 501c3 status.
Owners are typically hesitant to forfeit their economic rights in an LLC. It is more common for LLC members who want to start a nonprofit to incorporate a new entity in the form of a non-stock corporation which has a nonprofit mission statement from its inception.
Why form a 501c3?
A 501(c)(3) provides not-for-profits with the tax relief that they are due based on the good they provide the community they are servicing. Without a 501(c)(3) tax exemption, the not-for-profit is defaulted to a taxable entity status and this will take away valuable funds from the cause that the not-for-profit is supporting.