Key Takeaways

  • A nonprofit corporation is organized to serve the public interest and may qualify for state and federal tax exemptions.
  • Some states allow nonprofits to form as LLCs, though IRS rules impose strict requirements for tax-exempt status.
  • States like Delaware, California, Michigan, Minnesota, Texas, Kentucky, Tennessee, and North Dakota permit nonprofit LLCs under specific conditions.
  • To gain federal tax exemption, all members of a nonprofit LLC must themselves be tax-exempt entities.
  • Choosing where to form your nonprofit also depends on regulatory environment, costs, and how favorable the state is for nonprofit activity.

Nonprofit Corporation: What Is It?

A nonprofit organization is one that has been 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.

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.

Disadvantage to Nonprofits That are Tax Exempt

Some disadvantages to incorporating include:

• Incorporating a nonprofit means more paperwork, additional fees and requirements, and additional regulation by the IRS.

• Filing for incorporation and tax-exemption can be complex, time-consuming, and a bit more costly than not incorporating at all.

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.

While nonprofits are generally organized as corporations, they can also be formed as LLCs in certain states, including Delaware, California, Michigan, Minesota, and Texas. While LLCs do not have tax-exempt status, a nonprofit operating as an LLC generally does so 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.

What States Allow Nonprofit LLCs?

While many nonprofit organizations incorporate, several states also permit the creation of nonprofit LLCs. States that generally allow this structure include Delaware, California, Michigan, Minnesota, Texas, Kentucky, Tennessee, and North Dakota. However, state law is only one piece of the puzzle.

On the federal level, the IRS will only grant tax-exempt status to a nonprofit LLC if all members are already recognized tax-exempt organizations. For example, if several charities join together to form a nonprofit LLC, the entity may qualify for federal tax exemption.

Some states require nonprofits formed as LLCs to state a charitable or public purpose in their articles. Others restrict the distribution of profits to members, requiring that all assets be dedicated to nonprofit purposes. Because of these varying rules, nonprofits considering the LLC structure must carefully review both state requirements and IRS guidance before forming.

How Can I Incorporate a Nonprofit?

If you wish to have your nonprofit treated as a corporation, there are several steps you must take in order to incorporate your nonprofit organization, which include:

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 on a daily basis. 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 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.

Choosing the Best State for a Nonprofit

In addition to knowing what states allow nonprofit LLCs, it’s also wise to evaluate which states are most favorable to forming a nonprofit organization in general. Factors to consider include incorporation fees, reporting requirements, and state tax exemptions.

  • Delaware is a popular choice due to flexible business laws, though it may be more beneficial for larger organizations.
  • California offers wide opportunities for charitable activity but has higher compliance and reporting obligations.
  • Texas and Florida provide low filing costs and generally favorable nonprofit climates.
  • New York is known for strict regulations, making it less attractive for smaller nonprofits.

Ultimately, the “best” state depends on the nonprofit’s size, mission, and fundraising goals. Some organizations incorporate in their home state to simplify compliance, while others select states like Delaware for strategic advantages.

Applying for Nonprofit Status

When starting a nonprofit, the first step is to clearly define your mission and purpose. You should consider whether forming a nonprofit makes sense at this stage of your organization’s development. Nonprofits can be structured as corporations, trusts, unincorporated associations, or—in some states—as LLCs. Because the process can be complex, many organizations hire an attorney familiar with nonprofit law to help navigate the requirements and determine the best state for incorporation.

Applying for Tax-Exempt Nonprofit Status

Obtaining tax-exempt status is a separate step from forming the nonprofit itself. To qualify, your organization must be properly registered in the state where it operates. An attorney can conduct preliminary research to assess the likelihood of approval. Once the organization is formally established, you must apply for exemption through the IRS and, in some cases, your state’s tax authority. Until approval is granted, the nonprofit remains subject to federal, state, and local taxes.

Not All Nonprofits Are Tax-Exempt

It is important to note that not every nonprofit organization automatically qualifies for tax-exempt status. For example, some charitable groups remain unincorporated, which prevents them from obtaining the benefit. Similarly, small or temporary projects may not meet the IRS threshold. To qualify, nonprofits must satisfy three primary tests:

  • Organizational Test: The nonprofit must be structured to benefit the public in recognized charitable categories, such as education, religion, or the prevention of cruelty to children or animals.
  • Political Test: The nonprofit cannot engage in political campaigns or allocate resources for political purposes.
  • Asset Test: The organization must demonstrate that assets will not be distributed for personal gain to members, employees, relatives, or supporters.

What Tax-Exempt Status Means

Tax-exempt status relieves nonprofits from paying corporate income tax on revenue earned in pursuit of their charitable purpose. While this benefit reduces financial burdens, it is not automatically granted—organizations must apply and qualify. Additionally, some states extend exemptions from sales tax and property tax, even if the nonprofit does not meet all federal requirements.

When to Apply for Tax-Exempt Status

Applying for tax-exempt status makes sense when your nonprofit intends to operate long-term and falls within one of the 29 categories of charitable organizations recognized by the IRS. If you plan to apply for grants regularly, exemption is especially valuable, as many grantmakers require it.

However, there are times when applying may not be necessary. If your nonprofit is uncertain about its future, does not rely on financial assistance, or has a fiscal agent willing to manage grant applications on its behalf, then pursuing exemption may not be worthwhile.

Frequently Asked Questions

1. What states allow nonprofit LLCs?

Delaware, California, Michigan, Minnesota, Texas, Kentucky, Tennessee, and North Dakota permit nonprofit LLCs, though requirements vary.

2. Can a nonprofit LLC qualify for federal tax-exempt status?

Yes, but only if all members are recognized tax-exempt organizations. Otherwise, the IRS will not grant exemption.

3. Why do some states restrict nonprofit LLCs?

Because LLCs are designed for profit-sharing, states often require nonprofit LLCs to prove their assets and activities are dedicated to charitable purposes.

4. What is the difference between a nonprofit corporation and a nonprofit LLC?

A nonprofit corporation is the most common structure and more easily qualifies for tax-exempt status. A nonprofit LLC is less common and subject to stricter rules.

5. What are the best states to form a nonprofit?

Delaware, Texas, and Florida are often considered favorable, while states like New York have stricter regulations that may increase compliance burdens.

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