LLC vs. Nonprofit: Everything You Need to Know
The main difference when comparing an LLC vs. nonprofit is that a nonprofit has obtained a tax-exempt status and serves public interest.5 min read
Updated May 5, 2022:
When comparing an LLC vs. nonprofit, a nonprofit has obtained a tax-exempt status and serves the public interest, while a limited liability company (LLC) does not necessarily do so. However, in some cases, an LLC can also be a nonprofit.
What Is an LLC?
An LLC, or a limited liability company, operates essentially as a corporation, sole proprietorship, and partnership all in one. An LLC affords its members with limited liability as they cannot be held personally liable for the company's debts.
What Is a Nonprofit?
A nonprofit organization is established to meet certain tax exemptions and serve the public interest. All assets of a nonprofit must be either reinvested into the organization, given to the public, or given to another charity. Should the nonprofit not meet the needs of the general public, its tax exemption benefit will be taken away.
Similarities and Differences Between an LLC and Nonprofit
Nonprofit organizations enjoy the same liability protection as any other corporation or LLC. Therefore, any directors, members, employees, or other similarly situated executives of a nonprofit organization cannot be held personally liable for the nonprofit's debts. Many tax benefits are available to nonprofits, including the ability to receive grants from both the federal government and private foundations.
While LLCs are not awarded the same tax benefits as a nonprofit, limitations on a nonprofit's spending abilities do not apply to an LLC. In addition, a nonprofit has limitations on political speech than an LLC need not worry about.
The other distinction between an LLC and nonprofit is the economic purpose as to why it was established. The primary purpose of any nonprofit is to provide a service to the general public whereas the purpose of forming an LLC is to earn profit for its members.
Operating an LLC is rather simple, with very little required paperwork and limitations. However, a nonprofit generally faces an uphill battle when attempting to register within the state where it operates, which will include a lot of paperwork as well as proof that it will operate to serve the needs of the public. Furthermore, nonprofits must always ensure that the earnings are not being distributed to any shareholders or employees.
While there are benefits to each type of business, it is important to keep in mind the following key points regarding nonprofit organizations:
- Nonprofits are formed under state law.
- Nonprofits generally apply for federal tax-exempt status; however, if the nonprofit isn't using its income to benefit the public, then the IRS can take away such exemptions.
- Not all states allow nonprofits to operate as LLCs.
- Nonprofits have to reinvest any income they earn back into the organization or give it away to another charity.
- Nonprofits are funded by donors who have no ownership rights.
- If a nonprofit closes, all assets have to be given away.
- Nonprofits have no shareholder's equity whereas LLC members do, in fact, have shares of equity in the LLC.
Benefits of a Nonprofit Corporation
Some benefits of establishing a nonprofit corporation include:
- Federal tax exemptions
- Obtaining private and public grants
- Low-cost postage
- Directors can serve with or without compensation
Although most would think that nonprofits can't sell goods or services for money, you can. Many nonprofit organizations make money selling all types of products and services. Moreover, a nonprofit can also pay salaries for any employees who work there. Keep in mind that these salaries must be deemed reasonable by the IRS.
Nonprofit: How Should You Organize Your Business
The most common type of business structure for a nonprofit is a corporation, which is formed and regulated under state law. Therefore, if a nonprofit incorporates, it must abide by the state requirements of a corporation. This includes:
- Drafting bylaws
- Filing the Articles of Incorporation with the state business registrar
- Hiring a board of directors/trustees
However, the nonprofit can still apply for tax-exempt status in an effort to avoid federal corporate income tax. Further, many states allow nonprofit organizations to avoid sales tax and property tax. Tax-exemption with the IRS is known as 501(c)(3) status.
While nonprofits are generally organized as corporations, they can also be formed as LLCs in certain states, including Delaware, California, Michigan, Minnesota, and Texas. While LLCs do not have tax-exempt status, a nonprofit operating as an LLC generally does so as long as the LLC elects to be treated as a corporation for tax purposes. Furthermore, the LLC must have a nonprofit purpose, which some states simply don't allow.
For example, some states require that when a business registers as an LLC, the application must state the purpose of the business. Nonprofits don't have a specific economic purpose but are rather charitable organizations organized to serve the needs of the public. Therefore, certain states simply do not allow nonprofits to register as LLCs. It is important to note that on a federal level, the IRS will not give a nonprofit LLC tax-exempt status unless all of the members are tax-exempt organizations themselves. For example, if four tax-exempt charities come together to create a nonprofit LLC, then the LLC will benefit from federal tax exemptions.
How Can I Incorporate a Nonprofit?
If you wish to have your nonprofit treated as a corporation, follow these steps:
- Step 1. Choose your business name.
- Step 2. Check availability to see if the name you chose is already taken.
- Step 3. Prepare and file the Articles of Incorporation.
- Step 4. Create the bylaws, which will detail how your corporation will operate. You must also include the decision makers of the corporation. Note that this document does not need to be filed within the state you are incorporating, but you should keep a copy for your own records.
- Step 5. Hold a meeting. This meeting will identify all trustees or board of directors chosen, adopt the bylaws that were previously written, specify an annual budget, fundraising plans, as well as any other important matters, i.e., tax records, opening a business bank account, etc. Be sure to keep minutes of the meeting as this is one of the requirements for incorporating.
- Step 6. Apply for an Employer Identification Number (EIN). This can be done online with the IRS as it is necessary for tax purposes. All corporations are required to obtain an EIN. The state in which you incorporate may also require an additional EIN be obtained at the state level.
- Step 7. Submit your tax exemption application. Initially, your nonprofit corporation will be subject to all federal, state, and local taxes; however, you must apply for federal tax exemption in order to enjoy the tax benefits for nonprofits.
If you need additional help learning about an LLC or nonprofit, you can post your legal need on UpCounsel's marketplace. UpCounsel accepts only 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.