Nonprofit vs LLC

Dear M&M:

I am getting ready to form my company and I heard it is better to be a nonprofit.  My business partner said that is the wrong way to go.  Could you please tell me what is the difference between an LLC and a nonprofit is?

-Gary

Dear Gary:

A limited liability company is a favorite of small business because it offers protection of personal assets from a company’s debts under a simple business structure. A nonprofit organization is a legal structure required of a group or association to make it eligible for tax exemption. The differences go beyond that, though in some carefully defined circumstances an LLC can be a nonprofit.

Simple vs. Complex: A major advantage of an LLC is its simplicity. An LLC is formed under state statutes with little paperwork and few restrictions on ownership or purpose. A nonprofit can face a blizzard of paperwork to verify its charitable, artistic, public service, trade group or other eligible purpose as defined by the Internal Revenue Service. There’s more paperwork to keep track of funds and donations to ensure that no earnings are distributed to any private shareholder or individual. States will typically require a nonprofit organization to have a board of directors and maintain minutes of regular meetings, as they would with a for-profit corporation.

Pass-Through Taxes vs. No Taxes: Another key advantage of an LLC is that it allows income and losses to be reported on its owners’ personal tax returns, avoiding a double tax imposed on corporate profits—one on the company and the other on personal shares of profit distributed as dividends. There is no distribution of profits or income to shareholders in a nonprofit organization, nor is any legal sense of ownership extended to individuals. A nonprofit, though, can pay wages to employees and managers.

Flexibility: An LLC is flexible and can easily adjust to changing operating conditions. Its owners, called members, can distribute profits to themselves disproportionate to the amount of funds each invested, giving more to a managing member. It can also choose how to be taxed, either as a partnership or sole proprietorship for a single-member LLC, or as a corporation when profits reach a point where the latter may make financial sense. A nonprofit organization is held to rigid state and federal requirements to maintain its nonprofit status. The IRS says an organization can lose that status if it fails to “operate exclusively for exempt purposes.”

LLC as a Nonprofit: Despite the differences, a nonprofit LLC is allowed in several states, including Texas, California, Tennessee, Michigan and Minnesota. These states that allow them have either enacted specific legislation for nonprofit LLCs or use the clause in general enabling legislation that says LLCs may for formed “for any legal purpose,” which is interpreted by the states and the IRS to include a nonprofit purpose. But IRS regulations will not give a nonprofit LLC tax-exempt status unless all its members are themselves tax-exempt organizations. A group of charitable organizations, for instance, can form a trade group as an LLC and be granted tax-exempt status.

For-Profit LLC Owned by a Nonprofit: The IRS also allows a nonprofit organization to form a for-profit LLC if the LLC’s operations are ancillary to the organization’s purpose. This allows a nonprofit community art institute to form a for-profit gift shop as an LLC. The gift shop’s profits may be minor compared with the art institute’s total budget, and the shop itself can further the goals of the parent organization by selling affordable art and related goods to the public. Arizona has more than 20,000 nonprofit organizations. It is highly recommended that one contacts legal counsel from someone well-versed in the law and excels at utilizing the law to benefit your needs. I would not take this on as a do-it-yourself project.

Points of contact for Arizona Corporation Commission c/o Annual Reports, Corporations Div. 1300 West Washington, Phoenix, AZ 85007-2929 Information: (602) 542-3285 Forms: (602) 542-0082 Web Site: www.azcc.gov and the IRS,  Internal Revenue Service Ogden, UT 84201-0027 Information: (800) 829-1040 Forms: (800) 829-3676 Web Site: www.irs.gov/charities

To ask your questions: Call the Small Business Development Center(SBDC) at Cochise College (520)-515-5478 or email schmittm@cochise.edu or contact the Sierra Vista Economic Development Foundation(EDF) at 520-458-6948 or email  hollism@svedf.org

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