Should a nonprofit be an LLC or a corporation? Sometimes business owners have this question when deciding what form the business should take. Many factors can influence that choice, but you should undoubtedly have consideration of two business aspects in particular. Have a clear notion of what your intended transacting nature will be like, and determine in what ways you will fund your venture.

An LLC might be an appropriate business form if you plan to:

  • Participate in regular commerce.
  • Facilitate profit payouts.
  • Cultivate investment.

A nonprofit structure might be a better form for your business if you seek to:

  • Solicit donations from others.
  • Partake in charitable activities.

To simplify the terms defining nonprofits or LLCs by looking at business intent, you can say a nonprofit wants to serve the public with its business offerings. Members of an LLC wish to generate profit through business efforts.

What Does It Mean to Be Tax-Exempt?

Aside from the differences in business nature and ways of funding with an LLC versus a nonprofit, the most significant difference between the two forms is that it can only be possible for a nonprofit corporation to get recognized as a 501(c)(3) tax-exempt entity. The IRS gives a nonprofit organization this classification due to its charitable existence, which excuses the business from having to pay income taxes.

For an association or group to qualify for tax exemption, their legal structure must get recognized as being a nonprofit organization. An LLC might engage in different charitable activities, but since it operates as a regular business, it is not eligible for tax-exempt status.

For liability protection, a nonprofit corporation benefits from the same lawful security as an LLC and a regular corporation. Just like those working at the for-profit companies, the employees, directors, members, and trustees of a nonprofit share no liabilities or responsibilities for the debts of the business.

Incorporating as a nonprofit offers the organization considerable advantages in state and federal taxation. Some kinds of tax exemptions that nonprofit corporations are eligible for do not get presented to an LLC. However, a limited liability company does not have limits placed on its political speech or company spending like those imposed on nonprofit corporations.

When forming a nonprofit organization, a specified charitable purpose must be established. Then, it is up to the nonprofit to uphold that same purpose each year it remains in existence.

Does Having Members as Owners Prevent LLCs From Tax Exemption?

Different from a non-stock corporation that has no stockholders, LLCs do not qualify to get a nonprofit, tax-exempt determination because its members are also the owners. 

An LLC can hold assets of a nonprofit corporation by becoming a qualified subsidiary of the nonprofit. The LLC becomes liquidated into the nonprofit entity, which becomes its only member. As a result, management of the limited liability company only does what its parent allows. 

The LLC's operating agreement would need to be changed to reflect how, as a qualified subsidiary, the LLC cannot go against the restrictions or bylaws of the corporation. Tax exemption comes at the cost to the LLC by relinquishing member-managed authority. 

Benefits of Incorporating With Nonprofit Status

A corporation qualifies for nonprofit, tax-exempt determination when, by forming the business entity, at least one of the parties listed benefits from it:

  • The membership of the nonprofit
  • A particular group of people
  • The public

All donations and funds must be tracked with careful attention. You must ensure that at no time any portion of the company's income gets handed to an individual or private shareholder. As a nonprofit, earnings cannot get distributed among shareholders, and no legally recognized ownership of the corporation should get offered to anybody.

It takes a significant amount of additional work to maintain, but when a corporation gets recognized by the state as having a charitable existence, the benefits earned should be worth the extra time and effort it takes. Some advantages of a nonprofit status include:

  • Money donated is tax-free
  • Personal assets protected from liability
  • Exemption from property, sales, and income taxes
  • Access to public and private grants given by federal government and private foundations
  • Postage at low rates

If you need help with knowing when should a nonprofit be an LLC or corporation, you can post your legal need in 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, Stripe, and Twilio.