LLC Tax Exempt: Everything You Need to Know
Is an LLC tax exempt? In some cases, yes, your LLC can be exempt from federal or state taxation. However, this usually requires completing several important steps. 3 min read
2. State Tax-Exemption for LLCs
3. Nonprofits Forming LLCs
4. Forming an LLC Nonprofit by IRS Rules
5. LLC Tax Status
Is an LLC tax exempt? In some cases, yes, your LLC can be exempt from federal or state taxation. However, this usually requires completing several important steps.
Federal Tax-Exemption for LLCs
There are several circumstances when the IRS will exempt an LLC from federal taxation:
- The LLC has filed Form 1023 for exemption under Internal Revenue Code 501(c)(3).
- The LLC is a disregarded entity and is its sole member is a 501(c)(3) organization.
- All members of the LLC are 501(c)(3) organizations and the LLC is treated as a pass-through entity.
In most cases, LLCs that are exempt from federal taxes under 501(c)(3) rules will not be responsible for expenditures from private foundation grants and will also be able to deduct charitable contributions.
State Tax-Exemption for LLCs
Even if an LLC has achieved federal tax-exempt status, it does not mean the company is exempt from state-level taxes such as property taxes or income tax. For instance, if you form your LLC in California, the LLC must be a title-holding company to be exempt from the franchise tax and income taxes. If your LLC qualifies for the welfare exemption, it can be exempt from state property taxes.
Nonprofits Forming LLCs
There are a variety of reasons that a nonprofit may wish to form an LLC. For example, the nonprofit can use the LLC to protect itself from the risks of owning certain assets or performing certain activities. It's also possible that the nonprofit wishes to run a business that could put its 501(c)(3) status at risk, which is a good reason for a nonprofit to form an LLC. However, when forming an LLC for this purpose, the business will not be tax-exempt.
Some nonprofits form LLCs because they are interested in partnering with another entity in a joint venture. If the members of the LLC are tax-exempt, or if the member includes both for-profit and non-profit organizations, it's possible for the LLC to be tax-exempt.
Forming an LLC Nonprofit by IRS Rules
The IRS alone will decide whether your company will be tax-exempt when forming an LLC nonprofit. For an LLC nonprofit to be tax-exempt, all company members must be nonprofit organizations who are tax-exempt. There are also complex rules you must follow when applying for this status.
In your LLC's organizational documents, a statement should be included that limits the activities of your LLC to tax-exempt purposes. The language you use when organizing your LLC must make it clear that the only reason the company exists is the member's charitable purposes. Your LLC's organizational language must also mandate that only 501(c)(3) organizations or government units can be members.
The organizing documents of your LLC must state that company assets and interests can only be transferred to a nonmember for fair market value. This excludes LLC ownership interests. Your organizational language is also required to state that the LLC's assets that are used for charitable purposes will continue to be used for these purposes after the LLC has been dissolved. When making amendments to the Articles of Organization for your LLC nonprofit, these amendments must comply with 501(c)(3) rules.
Your LLC nonprofit is prohibited from transitioning to or joining a for-profit company. You cannot distribute assets to members of your company that are no longer 501(c)(3) organizations. Because it's possible that one or more members may lose their 501(c)(3) status at some time in the future, your organizational language must include a method for dealing with this circumstance.
It's also required that your organizational language direct your LLC's tax-exempt members to enforce their rights in the company and protect their interests as fully as possible. When you are writing the provisions in your LLC's organizing documents, you should be sure that they comply with state laws and that the provisions can be easily enforced.
LLC Tax Status
There are no tax categories that are specific to LLCs, mostly because these entities are very new. Single-member LLCs are treated as sole proprietorships by the IRS. The IRS will treat multi-member LLCs as partnerships by default. Although LLCs are not taxed directly, the income that the company earns will be taxed on its owner's personal returns. This is known as pass-through taxation.
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