What’s the Difference Between LLCs and Nonprofits?
LLCS and Nonprofits Are Both Business Types
Choosing a business structure is an important step in forming any company. New business owners can choose to set up a limited liability company (LLC), or a nonprofit organization. While LLCs and nonprofits share similarities in operations or protection, they also differ when it comes to tax status or purpose.
When comparing an LLC vs a nonprofit structure, a business must decide whether its purpose is to make a profit or to serve the public interest. Other factors to consider include the number of owners, how flexible operations should be, and the future of the business.
What Is an LLC?
An LLC is a type of business structure that combines many features of corporation and partnership structures. An LLC exists as an entity separate from its owners, who are called “members." Members cannot be held personally liable for the company’s debts unless they’ve signed a guarantee. The number of members allowed in an LLC is unlimited. Members can be individuals, corporations, or other LLCs. The main purpose of an LLC is to earn a profit for its members.
Advantages and Disadvantages of Choosing an LLC
Since members cannot be held personally liable for the company’s debts, an LLC provides some protection against financial problems or lawsuits. An LLC also has some flexibility when it comes to profit distribution. Unlike common partnerships that require an equal split, an LLC distributes its profits, losses, and expenses to each member depending on their ownership.
Because of this structure, members also avoid double taxation: paying both corporate tax and individual tax. Finally, an LLC doesn’t require formal meeting minutes or resolutions on the record as corporations do. Operations can be easier to run. Members can manage an LLC’s operations themselves or mimic a corporation’s structure by using a board of managers to run the company.
However, there are disadvantages when choosing an LLC. All 50 U.S. states allow the formation of LLCs but setting up and running an LLC can be more complex than choosing other structures, like a sole proprietorship or partnership. Unlike a corporation that can live indefinitely, an LLC is dissolved if it undergoes bankruptcy or if one of its members dies.
What Is a Nonprofit?
The Internal Revenue Service designates a nonprofit organization as a tax-exempt entity. Nonprofits don’t pay federal income taxes in recognition of their mission to serve the public interest.
Many people think a nonprofit cannot have a profit, but that is not true. A nonprofit reinvests any profits back into the organization to fund its purpose. A nonprofit's main purpose is to contribute to a community’s welfare rather than pursue a profit.
Unlike public and private companies that have owners or shareholders, when nonprofits bring in more money than their expenses those profits do not “inure” to any person or group of people. That is one of the most defining differences between for-profit and nonprofit.
A nonprofit receives a specific designation from the IRS, depending on what it does and whom it serves. Some of the best known are charitable nonprofits (for example, the American Red Cross) or foundations (think of the Ford Foundation) known as 501(c)(3)s. Charitable nonprofits are also known as public nonprofits because they derive a great deal of their support from the general public, and can be operated by a mix of volunteers and paid staff. Moreover, donors may be able to take a tax deduction for their contributions to the charity.
Other nonprofits with different IRS designations look more like businesses such as a credit union (501(c)(1), while others serve specific groups such as sports clubs 501(c)(7), or they might be a social welfare organization 501(c)(4).
Advantages and Disadvantages of Choosing a Nonprofit
Like LLCs, nonprofit organizations also have liability protection if incorporated. Directors, executives, members, and employees are not held liable for the organization’s debts. Also, grants from the federal government, private foundations, and corporations are often available to nonprofits.
However, a nonprofit organization must maintain the purpose that was chosen when it was formed. This adherence to a specific purpose prevents some flexibility that LLCs generally enjoy. Nonprofits can lose their IRS designation for several reasons including too much political activity or too much unrelated business activity. Moreover, while a business can be sold or closed, a nonprofit’s assets must be given to another nonprofit if it closes.
Nonprofit Business Structures
Nonprofits are commonly organized as corporations, which are formed and regulated under state law.
A nonprofit wishing to be treated as a corporation must do the following:
- Choose a business name that isn’t in use.
- Prepare and file articles of incorporation with the state business registrar. Articles of incorporation outline the purpose and function of a company, contact information, and other information.
- Draft bylaws explaining how the business will operate. State-specific laws govern what bylaws can say and do.
- Hold a meeting to discuss the operations with a board of directors or trustees. You’ll go over issues like budget, tax records, bank accounts, or fundraising plans.
- Obtain an Employer Identification Number (EIN). An EIN is required for tax purposes.
- Apply for federal tax exemption from the IRS.
Can Nonprofits Register as an LLC?
One thing that some new businesses consider is filing as both a nonprofit and an LLC. Nonprofits can be formed as LLCs in the majority of the U.S. states, but the terminology and technicalities can be complex.
A nonprofit that wishes to operate as an LLC would likely be called a “nonprofit LLC” or a “nonprofit liability company” depending on the state. Nonprofit LLCs are technically tax-exempt LLCs that are formed and operated for charitable purposes. While they may be exempt from federal income tax, they may not be exempt from state income or state property tax.
A nonprofit may want to operate this way if its founders wish to operate a joint venture with other entities or establish an unrelated business to bring in revenue to supplement income from donations and grants. However, this structure is uncommon because of the complexity involved.
For-profit businesses that wish to incorporate a social purpose do have alternatives to the traditional nonprofit or the nonprofit LLC. For instance, some organizations become benefit corporations (B Corporations) or L3Cs (low-profit limited liability companies).
Which Business Structure to Choose?
Whether you choose an LLC, a nonprofit, or another structure for your business, it’s important to research the requirements for each based on where you live. Deciding on the proper structure can be a long process, but the upfront research and filing involved is critical if you want to build a successful business, whether for-profit or nonprofit.