A limited liability company, or LLC, is a popular entity form for new businesses thanks to its inherent flexibility and numerous benefits. It therefore makes sense that charitable organizations would want to establish LLCs for their endeavors. Can an LLC be structured as a non-profit entity, and if so, what steps must be taken to ensure compliance? In short, the answer is yes – an LLC can function as a non-profit, provided it satisfies specific conditions under current tax laws.
What is an LLC?
An LLC is a business entity that combines structural flexibility with protection from personal liability for owners. The flexibility of the LLC come from its likeness to a partnership in that it is not subject to many mandatory governance requirements. For example, while traditional corporations must have separate shareholders and managers, members of an LLC can choose to both manage and hold shares of the business.
LLCs are also easy to form and can be organized as pass-through entities. This means that the tax on the profits and losses are “passed through” to the individual tax returns of members instead of imposed at both corporate and individual levels.
What is a Non-Profit?
A non-profit is an organization formed for a charitable, educational, religious, or other socially beneficial purpose. The term “non-profit” refers to how these organizations reinvest earnings into their mission instead of distributing profits or dividends to shareholders.
Although people often refer to the “501(c)(3)” as the formal legal entities for non-profits, this designation actually refers only to the tax-exempt treatment of these organizations under the federal Internal Revenue Code (“IRC”). An organization that qualifies for tax-exempt status under the IRC is not required to pay taxes on profits, and any donations made to the organization are deductible for donors. The formal legal entity of a non-profit is a different element of its structure and most commonly takes one of two forms: corporation or LLC.
Can an LLC be a Non-Profit?
Yes, an LLC can be a non-profit and get tax-exempt status by meeting IRS conditions. The IRS’s current position is that an LLC qualifies for 501(c)(3) or 501(c)(4) tax-exempt status if the LLC’s articles of organization and operating agreement each include the following:
- The mandate that any member of the LLC be either a 501(c)(3) tax-exempt organization or a governmental unit (or a wholly owned instrumentality of a governmental unit).
- Provisions setting forth the organization’s charitable purpose(s) and detailing that its assets will be distributed for a charitable purpose(s) if the company dissolves.
- Provisions for special excise tax mandates, only if the LLC is a private foundation.
- An acceptable contingency plan in the event that one or more of the LLC’s members cease to be a 501(c)(3), governmental unit, or wholly owned instrumentality of a governmental unit.
Whether an LLC can meet these conditions may be a matter of location, as every state has its own regulations surrounding LLCs. Several states, including Tennessee and Minnesota, have created a “non-profit LLC” designation that may streamline the process of meeting the conditions. Other states require that LLCs have only a “business purpose.” This may mean that in those states an LLC is incompatible with tax-exemption because that status requires an “exempt purpose,” i.e., a socially beneficial mission.
Conclusion
As with any corporate formation, it is essential to consult an experience attorney when forming a non-profit as an LLC. Properly constructing the articles of organization and operating agreement for your non-profit LLC can prevent major issues down the road. Contact us to speak with a member of our team.
