LLC as a Nonprofit: Possible or Not?

Can an LLC be a nonprofit? Yes, it is possible for a limited liability company (LLC) can be a nonprofit organization, but it’s rare due to the rules and restrictions in place to open it. For that reason, most nonprofits are corporations. However, if you want to create a non-profit LLC, it’s possible in most states. Read on to see if forming a nonprofit LLC is ideal for you. 

What Is a Nonprofit LLC?

A nonprofit LLC is a limited liability company formed for charitable, not-for-profit purposes. These limited liability companies are treated as tax-exempt 501c3 organizations for tax purposes. The primary purpose of an LLC is to protect its members from personal liability. In the case of a nonprofit LLC, the member groups of the LLC must be 501c3 nonprofit organizations.

Nonprofit Corporation vs. Nonprofit LLC

Both nonprofit corporations and nonprofit LLCs are business structures with nonprofit tax-exempt status. Nonprofits focus on promoting initiatives such as education, religion, charity, literary, or other goals for the public good. While nonprofits can have a narrow or specific reach, they all are formed without the goal of profits in their statutes. 

While an LLC and a corporation are both business entities, which must apply for an EIN,  there are fundamental differences in how they are created and operated. 

A corporation’s more rigid operational structure includes directions, officers, and shareholders. There are requirements for meeting frequency and reporting, as well as shareholders should comply with state laws.

The major advantage of an LLC is its more flexible structure. As the name implies, a limited liability company limits the liability of its members. Your personal assets are protected from the liability of business debt or obligations. Compared to a corporation, an LLC has fewer requirements and obligations. 

IRS Rules for Forming a Nonprofit LLC (Tax Exemptions)

While it is possible to form a nonprofit LLC, the IRS sets out 12 requirements. Fundamentally, the member(s) of a nonprofit LLC must meet the IRS’s conditions for 501c3 status.

State laws regulate LLCs. If you want to form a nonprofit LLC, you’ll first need to check if there are laws in your state that restrict forming a nonprofit LLC. Several states have laws requiring businesses to be formed only for business purposes. Forming an LLC in that state won’t be possible in such cases. You can, however, form an LLC in a state other than your residence. 

Conditions for 501(c)(3) Status as an LLC

If you want to form a nonprofit LLC, it’s important to understand if it can qualify for 501(c)(3) status. Gaining 501c3 status means that the organization is exempt from federal income tax. This has major advantages for nonprofit operations as donations are tax-exempt and there are tax advantages for donors. 

A nonprofit LLC could qualify for the 501c3 status if it meets one of three basic criteria:

• It’s a single-member LLC, which is a 501c3 organization.
• The LLC has two or more members, which are 501c3 organizations.
• The LLC has filed Form 1023 with the IRS (which still requires the member groups to be 501c3 organizations).

With single-member or partnership LLCs, the IRS will treat the LLC as a partnership or sole proprietorship, meaning it applies pass-through taxation to the members of the LLC. If you use Form 1023 to form a nonprofit LLC, the IRS will treat the LLC as a corporation for tax return filing purposes. 

Beyond the basic 501c3 structure for LLC members, the IRS specified 12 conditions for creating a nonprofit LLC and lists them in a Limited Liability Companies as Exempt Organizations-Update document. Meanwhile, the non-profit LLC can’t perform any activities that 501c3 organizations can’t. In addition, organizational language for the LLC must be consistent with the laws of the state. 

Here are the 12 criteria laid out by the IRS regarding the organization’s language and articles of incorporation that define roles and functions:

1. The organization’s documents must include a statement that limits exempt activities to one or more.

2. The organizational documents must clearly state that the LLC is operating only to further charitable purposes. 

3. The organization may only permit 501c3 organizations, governmental units, or instrumentalities of a state or political subdivision as members. 

4. The organization may only transfer the direct interest of any LLC membership to a 501c3 organization or a governmental unit.

5. The organization must state that LLC interests or assets can only transfer to a non-member other than those stated above for its fair market value. 

6. The organization must guarantee that all assets will be devoted to charitable purposes if or when the LLC is dissolved.  

7. Any amendments to the articles of organization must remain consistent with section 501c3 of the tax code.

8. The organization may not merge with, convert into, or become a for-profit business entity.

9. The LLC can’t distribute any assets to member groups that cease to be 501c3 organizations.

10. The organization must include a reasonable contingency plan if one or more members do not remain a 501(c)(3) organization, governmental unit, or instrumentality.

11. The LLC must state that members will use their rights to protect the LLC, including legal and equitable remedies. 

12. The LLC’s documents must comply with state LLC laws.

Low-Profit Limited Liability Companies

Low-profit limited liability companies are a viable option instead of nonprofit LLCs in some cases. A low-profit LLC is a for-profit business entity that works for charitable purposes. Low-profit LLCs (sometimes called L3C) aren’t recognized as business entities in all states. Check if this could be a solution where you live. 

The advantage of an L3C is that they are significantly simpler to form and don’t have to adhere to 501c3 criteria. However, an L3C isn’t tax-exempt. They can make profits through capital investment. 

In some cases, private foundations will contribute to low-profit LLCs for a program-related investment. Private foundations and L3Cs have similar formation requirements, making the contribution process simpler for private foundations. 

Advantages of a Nonprofit LLC

The main advantage of a nonprofit LLC is that it has a more flexible structure. Key advantages include:

• Legal protection (limited liability) for members
• Separate entity status
• Tax exemption
• Fewer operational requirements compared to corporations
• Perpetual existence
• Possible access to grants
• Tax benefits for donors
• Professional credibility as a nonprofit organization
• Online application
• Can hire employees to work for nonprofit purposes

Limitations of a Nonprofit LLC

While a nonprofit LLC offers significant advantages, it’s not without limitations, including:

• More difficult to form than a corporate nonprofit organization
• All member groups must be 501c3 organization
• Public scrutiny (learn if an LLC can go public)
• Inability to contribute to political campaigns or lobby for certain causes

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