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