A express liability company (LLC) is a legal class of enterprise, owned by ane or more than members, that may be organized and operated for a wide variety of purposes, including charitable purposes. Ane of the major advantages of an LLC is the limited liability protection it offers to its members. Members are generally non liable for the debts and obligations of the LLC except to the extent of their investments in the LLC.

While technically, at that place is no such affair as a nonprofit LLC in the vast majority of states (Minnesota, Tennessee, and Kentucky being notable exceptions), in that location are revenue enhancement-exempt LLCs, and these entities are commonly referred to as "nonprofit express liability companies" or "nonprofit LLCs". For the purposes of this article, I'll refer just to tax-exempt LLCs that are organized and operated for charitable purposes.

Federal Revenue enhancement-Exemption

An LLC may be recognized by the IRS as tax-exempt for federal income tax purposes in whatever of these scenarios:

  1. The LLC may apply for recognition of exemption under Internal Revenue Code 501(c)(three) past filing Class 1023. See IRS Website.
  2. The LLC may be a disregarded entity for federal income taxation purposes and accept on the revenue enhancement characteristics of its sole member, a 501(c)(3) organisation.
  3. The LLC may exist considered a pass-through entity for federal income tax purposes and appropriately its income (and expenses) volition exist attributed to its members, all of which are 501(c)(3) organizations.

Generally, a domestic LLC exempt under Section 501(c)(3) of the Internal Revenue Code will be eligible to receive (a) deductible charitable contributions and (b) private foundation grants without the need for expenditure responsibility. See IRS Notice 2012-52.

See Instructions for Limited Liability Company Reference Guide Sail (IRS).

Country Tax-Exemption

While an LLC may exist recognized by the IRS every bit tax-exempt for federal income revenue enhancement purposes, this does non necessarily mean that it volition be recognized every bit exempt from state income taxes or land property taxes. In California, an LLC (other than one electing to be taxed equally a corporation) will be recognized as tax-exempt for state income and franchise tax purposes just if it is qualifies every bit a title-holding company under Revenue and Taxation Lawmaking Section 23701(h) or 23701(x). it volition exist recognized equally exempt from state property taxes if it separately qualifies under the welfare exemption.

Meet Limited Liability Companies and Tax-Exempt Status (Franchise Taxation Board); Limited Liability Companies As Revenue enhancement-Exempt Organizations; Limited Liability Companies and Qualification for the Welfare Exemption.

Employ of an LLC by a Nonprofit

A nonprofit may want to establish and ain an LLC for multiple reasons, including:

  1. To protect itself from the risks and liabilities associated with the assets or activities of the LLC. This isolation-of-take a chance strategy may be especially appropriate where the LLC's assets (e.g., real property with environmental risks) and/or activities (eastward.g., adventure camps) have a higher risk contour than the nonprofit's assets and activities.
  2. To operate a concern that is not substantially related to advancing its exempt purpose without exposing itself to revocation of its 501(c)(3) exempt status. This strategy is commonly employed where a nonprofit desires to carry on an unrelated business that is substantial in scope and size. In this case, the LLC will not be tax-exempt.
  3. To operate a joint venture with one or more than other entities. The LLC housing the articulation venture may be taxation-exempt if all of its members are tax-exempt or taxable if its members consist of both nonprofit and for-profit organizations.

Run across Single Member LLCs: The flexibility of limited liability companies is i asset for nonprofits (Alliance for Children & Families Magazine).

Financial Sponsorship Using an LLC (Model L)

A nonprofit fiscal sponsor may want to establish and ain an LLC to protect itself from the risks and liabilities associated with the avails or activities of the sponsored project. If accordingly structured, an LLC solely owned past a financial sponsor may be considered tax-exempt as a overlooked entity and seek out its own deductible charitable contributions and private foundation grants, as described above.

The Model L financial sponsorship strategy may exist worthy of consideration under a couple of circumstances:

  1. Where comprehensive fiscal sponsorship (Model A) is being considered but the risks and liabilities associated with a new project are of significant concern to the fiscal sponsor.
  2. Where an existing nonprofit wants to dissolve and transfer its programs to a fiscal sponsor but the fiscal sponsor is concerned about potential successor liability.
Problems

Among the bug for fiscal sponsors to be aware of before setting upwardly a Model 50 fiscal sponsorship:

  1. The activities of the LLC may be attributed to the fiscal sponsor for tax purposes. If the LLC engages in substantial lobbying (relative to the fiscal sponsor'due south limits) or prohibited political intervention activities, the fiscal sponsor's 501(c)(3) status may be jeopardized.  And the LLC's unrelated business activities may event in unrelated business concern taxable income to the fiscal sponsor.
  2. The LLC is itself a charitable asset owned by the financial sponsor impressed with a charitable trust. Appropriately, the board members of the fiscal sponsor have a duty to protect such nugget from misuse. The fiscal sponsor's pick of a manager to manage the LLC should accordingly be made with reasonable intendance (query whether information technology would be prudent to eliminate a manager's fiduciary duties to the fiscal sponsor, if possible). The financial sponsor itself will likely not want to exist the manager in order to mitigate against the possibility of ascending liability.
  3. The choice of the country in which the LLC is to be organized.
  4. The LLC may need to exist fairly capitalized to mitigate confronting the risks of veil piercing and ascending liability.
  5. There may exist different ways for the fiscal sponsor to be paid for such arrangement, including through fees or distributions to the sole member. Still, the payments should exist conspicuously defined in a written understanding to mitigate against the risks of veil piercing and ascending liability.
  6. The LLC will non be disregarded for employment taxation purposes and will take all of the responsibilities of an employer to the extent it has any employees.

See The Use of LLCs in Fiscal Sponsorship – A New Model (Taxation of Exempts); Successor Liability in a Model A Fiscal Sponsorship (Nonprofit Constabulary Matters, Adler & Colvin); Using LLCs in Financial Sponsorship: iii Detailed Responses to Questions (GrantSpace)

Use of an LLC Instead of a Nonprofit

An LLC tin have a social good purpose and, just like any individual, can engage in charitable and philanthropic activities. For federal income tax purposes, it may be a pass-through without any entity level taxes. Nonetheless, nether such circumstances, any cyberspace income of the LLC will be attributed, and may be taxable, to the individual owner(southward). For a charitably inclined owner, this may not be an issue, particularly if the LLC is non going to produce significant net income or will engage in earned income activities that would otherwise exist prohibited if run past a 501(c)(iii) nonprofit. In addition, equally a nonexempt entity, the LLC would not exist constrained by the tax laws applicable to 501(c)(3) organizations. Accordingly, in addition to making charitable grants to charities, which the LLC may exercise just like a foundation, the LLC may besides make investments in for-turn a profit social enterprises, engage in political campaign activities and unlimited lobbying, and enter into artistic collaborations with various for-profits, all of which may be impermissible to a 501(c)(3) nonprofit.

Run across Chan Zuckerberg Initiative – Taxable Social Enterprise – Office ii for a give-and-take of some benefits of using an LLC instead of a nonprofit.

Depression-turn a profit Limited Liability Companies (L3Cs)

An L3C is a special form of LLC that significantly furthers the accomplishment of i or more charitable and/or educational purposes. Generally, an L3C tin can be used in place of a traditional LLC in whatsoever of the scenarios to a higher place. See our earlier posts on the L3C.

2021 Revenue Ruling (UPDATED 12/23/21)

Find 2021-56

Guidance issued for LLCs seeking tax-exempt recognition (Journal of Accountancy, 10/22/21)

Deeper Dive (UPDATED 4/17/17)

Section 501(c)(three) Organizations, Single Member Limited Liability Companies, and Fiduciary Duties (Ellen Aprill, Loyola Law School)

Sample Questions [Applications for Exemption] – Limited Liability Company (IRS)