Can an LLC qualify as a 501(c)(3) organization?

Written By:
Adiste Mae

An LLC can be formed for any purpose (nothing illegal though!) so it can be argued that it can be formed for a nonprofit purpose right?

Assuming that the answer to the question is yes, the next question to ask would be “can it qualify as a 501(c)(3) organization just like a nonprofit corporation?”.

Seems like a worthy topic of discussion right?

In this article, we will explore if an LLC can be a nonprofit, if it can qualify as a 501(c)(3) organization, and the reasons why anyone would want to form a nonprofit LLC (if it can be formed at all).

What is a 501(c)(3)?

Section 501(c)(3) is a portion of the U.S. Internal Revenue Code (IRC) that specifies which non-profit organizations qualify for federal tax exemption.

As cited from Section 501 (c)(3) of the U.S. IRC, the following nonprofit organizations are exempt from federal income tax:

“Corporations, and any community chest, fund, or foundation, organized and operated exclusively for religious, charitable, scientific, testing for public safety, literary, or educational purposes, or to foster national or international amateur sports competition (but only if no part of its activities involve the provision of athletic facilities or equipment), or for the prevention of cruelty to children or animals, no part of the net earnings of which inures to the benefit of any private shareholder or individual, no substantial part of the activities of which is carrying on propaganda, or otherwise attempting, to influence legislation (except as otherwise provided in subsection (h)), and which does not participate in, or intervene in (including the publishing or distributing of statements), any political campaign on behalf of (or in opposition to) any candidate for public office.”

To summarize, if an organization is a (1) charitable organization, (2) church or any other religious organization, or (3) private foundation, then it should be exempted from federal income taxes as stated in section 501 (c)(3) of the U.S. IRC.

A unique trait that 501(c)(3) organizations have over other nonprofit organizations is that donations made to them are tax-deductible (on the part of the donors).

Nonprofit, 501(c)(3), and tax-exempt – are they the same thing?

While these three terms are often used interchangeably, they really don’t mean the same thing.

They are related though, so that may be the cause of confusion.

Nonprofit or nonprofit organization refers to an entity or organization (usually a corporation) that is organized for nonprofit purposes (e.g. religion, charity, education, collective social benefit).

Any income (revenue that exceeded expenses) generated by a nonprofit cannot be claimed by private parties.

It can only be used for the advancement of the organization.

501(c)(3) refers to a specific section of the U.S. IRC that states what nonprofit organizations are exempted from federal taxes.

If an organization meets the criteria stated by section 501(c)(3), then it may qualify for tax exemption.

Tax-exempt refers to the status of an entity (be it an individual or legal entity) that makes them exempt from the payment of taxes.

It can also refer to income or transactions that are tax-free either at the federal, state, or local level.

A nonprofit that meets the criteria stated in section 501(c)(3) of the U.S.

IRC is qualified for tax-exempt status.

It is to be noted that just because a nonprofit qualifies as a 501(c)(3) organization doesn’t mean that it is automatically tax-exempt.

It will still have to apply for tax-exempt status with the IRS.

If approved, then the nonprofit will become tax-exempt.

Can an LLC qualify as a 501(c)(3) organization?

Before we can answer this question, we need to know first if an LLC can be a nonprofit.

Typically, an LLC can be formed for whatever purpose so it can be argued that it can be formed for nonprofit purposes.

That should make the LLC a nonprofit right?

Well in substance, yes.

But most states don’t agree with that.

As of the publication of this article, only four states officially recognize nonprofit LLCs.

These states are Minnesota, Kentucky, North Dakota, and Tennessee.

Texas uses another terminology but it does allow the formation of an LLC with a nonprofit purpose.

Delaware uses the term non-profit instead.

Ohio does not have a separate classification for nonprofit LLCs, but it allows LLCs to be formed for nonprofit purposes.

Some states use the term “nonprofit liability companies” instead.

Some states however require that an LLC must be formed for a business purpose.

These states are California,  Indiana,  Iowa,  Maryland,  Minnesota,  New  York,  North Dakota, Rhode Island, Utah, and Virginia, along with the District of Columbia.

This makes it questionable whether or not you can form a nonprofit LLC in these states.

It’s probably best to not bother forming a nonprofit LLC in them to save yourself the trouble.

Okay, so now we’ve gathered that a nonprofit LLC can be formed in some states with some even officially recognizing its existence, we can finally talk about the elephant in the room: can an LLC qualify as a 501(c)(3) organization?

Well, the answer to that question is…  yes, a nonprofit LCC can qualify as a 501(c)(3) organization – but only under very specific circumstances.

Before a nonprofit LLC can qualify as a 501(c)(3) organization, it has to meet the twelve (12) conditions stated in the LIMITED LIABILITY COMPANIES AS EXEMPT ORGANIZATIONS ­ UPDATE (they can be found under the section 501(c)(3) Exemption for LLCs–12 Conditions).

Even if the conditions are met, a nonprofit LLC can only qualify as a 501(c)(3) organization under certain situations.

A page from the IRS website states that:

“A limited liability company that files Form 1023 is treated as a corporation rather than a partnership. As a corporation, it may file Form 1023. Note, however, that a limited liability company should not file an exemption application if it wants to be treated as a disregarded entity by its tax-exempt parent”

This means that a nonprofit LLC will have to forego its “pass-through entity” status and be treated as a corporation by the IRS before it can qualify as a 501(c)(3) organization.

Even if its application is approved, the nonprofit LLC is only exempt from federal taxes.

Whether it’d be exempt from state or local taxes is another matter.

But there’s are still situations where a nonprofit LLC can qualify as a 501(c)(3) organization without having to forego its “pass-through entity”.

These are as follows:

1. If it is owned by a single member which is a 501(c)(3) organization itself
2. If it is owned by two or more members, all of which are 501(c)(3) organizations

If the nonprofit LLC is only owned by a single member, the IRS will treat it as a sole proprietorship and if it is owned by more than one member, the IRS will treat it as a partnership.

By being treated as a sole proprietorship or partnership, the nonprofit LLC gets to keep its “pass-through entity” status.

In both situations, it is clearly defined that the members of the nonprofit LLC must be 501(c)(3) themselves.

This means that an individual or a group of individuals cannot own a nonprofit LLC that is also a 501(c)(3) organization, which makes it different from your usual LLC.

Why form a nonprofit LLC?

Forming a nonprofit LLC and having it qualified as a 501(c)(3) organization seems like a hectic task doesn’t it?

First, you’d have to meet certain conditions.

Next, you have to elect it as a corporation for tax purposes, foregoing its “pass-through entity” status -or- have a 501(c)(3) organization or a group 501(c)(3) organizations form it.

If you really want to form a nonprofit LLC that is qualified as a 501(c)(3) organization, you have to form a nonprofit corporation first, have it qualified as a 501(c)(3) organization, then have it form the nonprofit LLC you wish to qualify as a 501(c)(3) organization.

At that point, why not just stop at the formation of a nonprofit corporation and have it qualified as a 501(c)(3) organization?

Well, it may not make sense if you just want to start a nonprofit organization, but it does for already existing 501(c)(3) organizations.

It allows them to own or co-own a nonprofit LLC that is also a 501(c)(3) organization.

If a 501(c)(3) organization owns a nonprofit LLC, it can protect itself from the risks and liabilities that are associated with the assets and/or activities of the LLC.

This is particularly useful if the assets or activities of the LLC have a high-risk profile.

For example, a social welfare organization (think Red Cross) purchasing an ambulance can set up an LLC and have it take title to the vehicle.

This protects the organization from risk and liabilities should the ambulance cause uninsured liability.

Another reason for a 501(c)(3) organization to form an LLC is when it wants to operate a business that is not related to its core purpose but does not want to revoke its 501(c)(3) exempt status.

However, since the LLC does not meet the conditions stated in the LIMITED LIABILITY COMPANIES AS EXEMPT ORGANIZATIONS ­ UPDATE, it cannot qualify as a 501(c)(3) exempt status.

I’ve heard of the Low-Profit LLC or L3C. Can it qualify as a 501(c)(3) organization?

Short answer: no.

Long answer: A Low-Profit LLC or L3C is a hybrid business structure that combines certain aspects of an LLC and a nonprofit organization.

It has the legal existence and tax flexibility of an LLC and the social benefits of a nonprofit organization.

However, even though it shares some aspects with a nonprofit organization, it cannot qualify as a 501(c)(3) organization.

It can act as a substitute for forming a nonprofit LLC though.

Most attorneys don’t recommend the formation of an L3C though.

For one, its purpose can be done by a traditional LLC – the members can just agree to keep profits at a low level to help other causes.

This makes the formation of L3C a moot point.

In summary, a nonprofit LLC can qualify as a 501(c)(3) organization but only other specific conditions: if it’s owned by a 501(c)(3) organization or a group of 501(c)(3) organizations -or- if it is elected to be treated as a corporation by the IRS and it files a Form 1023.

An individual or a group of individuals cannot own a nonprofit LLC that is also a 501(c)(3).