Can I Form a Non-Profit LLC, 501c3?

What Is a 501(c)3 Organization?

501(c)3 is an IRS code section that defines what qualifies as a tax exempt organization under federal law. To receive a tax determination letter from the IRS, approving the 501(c)3 status, a non-stock corporation must submit a Form 1023 or Form 1023-EZ application with the Internal Revenue Service (IRS). A corporation must meet specific requirements to be eligible for 501(c)3. To receive 501(c)3 public charity or private foundation status, specific language must be included in the non-stock corporation’s Certificate of Incorporation.

Purpose
Acceptable charitable purposes include religion, charity, education, science, literature, testing for public safety, or promoting animal welfare.

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

1.  Form a non-stock corporation.
2. Complete IRS Form 1023 or IRS Form 1023EZ to apply for recognition of tax exemption status under section 501c3.
3. 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.

Can a 501(c)(3) Be an LLC?

Only very recently has the IRS started allowing LLCs to apply for tax exempt status directly. The reason very few LLCs seek tax exempt status is because for an LLC to submit the IRS Form 1023 and obtain a tax determination letter from the LLC, the LLC must be structured in such a way as to mimic a non-stock corporation, such that the LLC’s members are non-equity owners. Plus the LLC must provide for a board of directors and officers, rather than just a manager or managing member. That complex structure may be the reason that it is so rare for LLCs to request and obtain tax exempt status directly.

Instead, more common is for an LLC to be a wholly owned subsidiary of a 501(c)(3) exempt corporation. The IRS has provided guidance to make it clear that if the LLC subsidiary is limited to the purposes of its parent and entirely controlled by its parent 501(c)(3) then the LLC would also be exempt under that umbrella without needing to apply to the IRS. One example of why a 501(c)(3) corporation would setup an LLC as a subsidiary is to take title to an asset that may have contingent liabilities, such as a vehicle or a piece of land with possible environmental contamination. That subsidiary structure helps keep the liabilities at the child level to avoid giving those possible creditors access to the assets of the parent company.

Do 501(c)3s Pay Taxes?

If a corporation receives 501(c)3 status from the IRS, it is considered tax-exempt and therefore is not required to pay taxes to the federal government on its exempt income. This status also incentivizes individuals to donate money to their cause because all charitable contributions donated to a 501(c)3 are tax-deductible for the donor.

What Does a 501(c)3 Do?

A 501(c)(3) is a tax-exempt nonprofit organization whose purpose is to engage in charitable purposes. These purposes include charities, food banks, churches, educational nonprofits, animal shelters, and research organizations. In a broader sense, the service must be recognized by the Internal Revenue service as a charitable, educational, religious, scientific, or public-service purpose.

501(c)(3) is a tax-exempt status allowing donors to make tax-deductible donations, and making the nonprofit eligible for foundation grants. A qualified 501(c)(3) nonprofit is not required to pay federal income tax due to its designation. Any contributions made by donors to fund these organizations allow for tax deductions. Likewise, 501(c)(3) organizations offer the eligibility for certain grants that are only available for use by these charitable organizations.

The 501(c)(3) exists solely for supporting the organization’s charitable mission. It cannot be used to benefit any private individual.

What Exemptions Do 501(c)3s Get?

Due to 501(c)(3) organizations being qualified nonprofits, they end up receiving many different tax and financial exemptions from the Internal Revenue Service and state governments.

Federal income tax exemption

Usually, 501(c)(3) organizations do not pay federal income taxes on any revenue generated to back the organization’s mission. The smallest nonprofits do not even need to file the IRS form 990 tax return, because they are only required to send in a post-card annually

Tax-deductible donations

Donors can often deduct contributions on their personal or business tax returns.

State tax exemptions

Many states exempt 501(c)(3)s from state income taxes, sales taxes, and in many cases property taxes.

Reduced postal rates

Eligible nonprofits may qualify for discounted mailing rates through the postal service.

Grant eligibility

Many government and private grants are only available to recognized 501(c)(3) organizations.

Certain fees and filing benefits

Nonprofits may qualify for reduced fees, exemptions, or special treatment in some regulatory areas.

Despite these exemptions, nonprofits still must follow strict rules. While officers and staff can request a reasonable salary, the income to the nonprofit must fund their mission and cannot be distributed to owners or private individuals.

Can I Form a 501c3 By Myself?

Yes, you can form a 501(c)(3) nonprofit by yourself. The two-step process requires to first form a non-stock corporation with three extra paragraphs in the Certificate of Incorporation. The second step involves applying to the IRS for a tax determination letter. A 501(c)(3) is a federal tax-exempt status granted by the IRS to qualifying nonprofit organizations.

The process typically includes:

• Forming a nonprofit corporation
• Preparing incorporation documents and bylaws
• Obtaining an EIN
• Having a board of directors with at least three people
• Filing the 1023 IRS application for 501(c)(3) recognition

Some smaller nonprofits may qualify to file the simplified Form 1023-EZ, while others must submit the longer Form 1023 application.

Although it is possible to create a 501(c)(3) on your own, mistakes in formation documents or IRS filings can lead to delays or future compliance issues. Organizations with plans for fundraising, grants, employees, or more complex operations may benefit from professional guidance.

One classic mistake is to use the default template for a Certificate of Incorporation on a Secretary of State website. This is a mistake because it leaves off the three paragraphs required by the IRS which will result in you needing to later Amend your Certificate of Certificate after the 1023 Application is first rejected by the IRS, costing more and delaying your approval by months.

Properly setting up your nonprofit from the beginning can help avoid problems and keep your organization focused on its purpose.

What’s the Difference Between a Nonprofit and 501c3?

The difference between a nonprofit and a 501(c)(3) is that a nonprofit describes an organization’s purpose and structure, while a 501(c)(3) refers to its federal tax-exempt status. Although the terms are often used interchangeably, they are not the same.

A nonprofit is an organization created to serve a mission or public benefit rather than distribute profits to owners or shareholders. A 501(c)(3) is a tax-exempt designation granted by the IRS to qualifying nonprofit organizations.

Forming a nonprofit does not automatically make it a 501(c)(3). To receive 501(c)(3) status, an organization must be properly formed under state law, meet IRS requirements, and apply for federal tax exemption. Approved organizations may qualify for benefits such as federal income tax exemption and the ability to accept tax-deductible charitable donations.

In short, a nonprofit is the organization itself, while a 501(c)(3) is the IRS classification that provides tax-exempt benefits. Understanding this difference is an important step when starting a nonprofit and choosing the right structure.

How Does a 501c3 Work?

A 501(c)(3) works by allowing a qualifying nonprofit organization to receive federal tax-exempt status while operating for an approved public benefit. A 501(c)(3) is not a type of business entity, it is a tax classification granted by the IRS to eligible nonprofit organizations.

To become a 501(c)(3) nonprofit organization, the organization must first be properly formed under state law and then apply to the IRS for recognition of tax-exempt status. Once approved, a 501(c)(3) may qualify for benefits such as federal income tax exemption and the ability to accept tax-deductible charitable donations.

A 501(c)(3) organization must operate according to IRS requirements. Its activities must support an exempt purpose, such as charitable, educational, religious, scientific, or other qualifying work. Any money the organization receives must be used to further its mission rather than provide private benefits to individuals.

Most 501(c)(3) nonprofits are governed by a board of directors and follow rules established in their bylaws. They are also responsible for maintaining records, meeting nonprofit compliance requirements, and filing required reports.

Understanding how a 501(c)(3) works can help founders decide whether forming a nonprofit and applying for tax-exempt status is the right choice for their organization.

MORE: How to Form a Non-Profit Corporation