Can an LLC Have a Nonprofit Subsidiary?
LLCs are not eligible for tax-exempt, or nonprofit, status because of the tax options owners are given to pass-through revenues.4 min read
Updated July 1, 2020:
Can an LLC have a nonprofit subsidiary? LLCs are not eligible for tax-exempt, or nonprofit, status because of the tax options owners are given to pass-through revenues. There is a potential workaround to this particular rule though. If the LLC is wholly owned by a parent corporation, the parent corporation could apply for the nonprofit exemption and pass that status along to the LLC.
LLCs appeal to both individuals and companies who are looking to start a new business because they combine a number of the advantages of both partnerships and corporations. When they're properly managed, an LLC can shield its members from personal liability for obligations and debts of the business. Corporations can start different LLCs for subsidiaries as a way to protect other aspects of the business, or someone can create an LLC in order to buy and manage investment property.
An LLC that is wholly owned by only one member is treated by the IRS as a disregarded entity. The LLC's owner can report the business's financial activities on their own tax return without being required to file an individual federal tax return for the business. This helps reduce the LLC owner's costs and time related to tax returns and still provides liability protections under the LLC structure.
Do Nonprofits Need LLC Subsidiaries?
Like their for-profit counterparts, nonprofits are subject to potential liability related to their business activities and any property that they own. In multiple scenarios, a single-member LLC (SMLLC) can protect the parent nonprofit by separating out specific activities that inherently have some degree of risk. Activities can include things like income property management and rentals or child care services.
SMLLCs are quite useful in situations involving donations of real property where there are possible environmental liabilities that are not known or when the parent organization wants to ensure it is excluded from the chain of title to prevent any future obligations. If an SMLLC is owned by a nonprofit, the nonprofit isn't required to file a separate application to obtain exempt status. The actions of the SMLLC will be treated as though they were part of the parent nonprofit organization.
Although the structure of the SMLLC provides the parent nonprofit organization numerous benefits in regard to liability property, it should not take advantage of the subsidiary in a way that could put its own nonprofit exemption at risk or create additional tax liabilities. The SMLLC is still treated much like a division or branch of the nonprofit, so it needs to avoid actions that could be viewed as contrary to the parent organization's charitable purpose. For example:
- The SMLLC cannot participate in work that could have a large nonexempt purpose, including ones that would produce excessive UBI, which is unrelated business income.
- The SMLLC cannot campaign or lobby for a particular political party or candidate.
Even in situations where the UBI is not enough to put the nonexempt status at risk, it still needs to be reported to the IRS, and the parent organization must pay tax on it. Passive income, like rental property income, is not considered UBI. This is why a nonprofit could benefit from an SMLLC subsidiary if they receive real estate donations. It can protect the nonprofit's other assets from any liability related to any donated property.
Consider reporting the SMLLC's actions on your IRS information return, like the Form 990. This will reflect the SMLLC as a disregarded entity much like you would if it was a subsidiary of a for-profit company. The IRS confirmed in 2012 that a donor can deduct donations to an SMLLC when the sole owner of the LLC is a charity.
Tips for Maintaining Separate Entities
The IRS offers tips for ensuring your for-profit subsidiary maintains a separate identity:
- Maintain a separate board of directors for each organization.
- Keep separate records and books for each organization.
- Have separate employees for each organization.
It's understandable that most nonprofits cannot afford to have separate staff for the subsidiary. If handled correctly, some administrative functions like space rental or payroll can be handled by the parent nonprofit without risk of penalty.
When negotiating a deal, use fair market value when determining what services or transactions are worth. If the transaction involves a high-value property, have an independent appraisal done. Be sure to get any agreements in writing. Transactions should be approved by both the parent and subsidiary and payments should be documented carefully.
Lastly, watch for board overlap. Creating a smaller board with outside directors is recommended.
If you need help with an LLC having a nonprofit subsidiary, you can post your legal need on UpCounsel's marketplace. UpCounsel only accepts the top 5 percent of lawyers to its site. Lawyers on UpCounsel come from law schools such as Harvard Law and Yale Law and average 14 years of legal experience, including work with or on behalf of companies like Google, Menlo Ventures, and Airbnb.