Can a Non-Profit LLC Be Tax Exempt?

Non-profit mailing labelWhen you talk about a non-profit business, you are generally talking about two things: being registered as a not-for-profit company in a state, and being recognized by the IRS as a tax-exempt 501(c) — typically 501(c)(3) — organization. Without approval by the IRS, your business will pay income tax whether or not you are a non-profit.

Though the laws surrounding LLCs are constantly changing and evolving, starting a non-profit LLC is probably not currently feasible. This is because a tax-exempt 501(c)(3) organization must be a “corporation, community chest, fund, or foundation” according to IRS rules. A single-member LLC is a “disregarded entity” for IRS purposes and so does not qualify under these rules. This also excludes partnerships with more than one member because the LLC is still a pass-through tax entity not recognized by the IRS.

LLCs may elect to be taxed as a C-Corporation by filing IRS Form 8832, which would make the LLC a taxable entity recognized by the IRS. This should qualify the non-profit company under the above quoted IRS rules, but there is another problem. According to the IRS publication Limited Liability Companies As Exempt Organizations:

Because state laws generally provide LLC members with ownership rights in the assets of the LLC, the Service is concerned that allowing non-exempt members would result in potential inurement problems. Thus, the LLC cannot have private shareholders or individuals as members, and its organizing documents must state a purpose to further the members’ charitable purposes. It should be noted, however, that the presence of solely charitable members does not ensure that the organization will be operated exclusively for charitable purposes.
(Emphasis added)

Though a group of non-profit corporations could collectively form a non-profit LLC, individuals could not be members of the LLC. This limitation likely disqualifies anyone who would be interested in creating a non-profit organization.

Incorporating a non-profit is still probably the best way to go. Although there seems to be some interest in the idea of tax exempt non-profit LLCs — especially with the creation of low-income limited liability companies, or L3Cs — the complexity of the filings outweighs any benefits conferred by the LLC structure.