The difference between a limited liability company (LLC) and a nonprofit organization may seem insignificant, but it can have long-lasting implications for your business.
We’ll help you decipher the critical aspects of each type of structure so you can make the right decision when choosing to start either one.
What Is an LLC?
LLC stands for “limited liability company.” An LLC is a type of business structure that provides the limited liability protection of a corporation with some of the tax benefits and operational flexibility of a partnership.
Most business structures limit your exposure to the debts and actions taken by your entity, but an LLC does this more than any other form under U.S. law.
This feature protects you from being held personally liable for lawsuits filed against your business or its creditors if your organization can’t pay its debts or gets sued because it acted negligently in conducting its affairs.
Pros and Cons of LLCs
- An LLC is one of the most accessible types of companies to form since you don’t have to file any legal paperwork with your state.
- An LLC provides pass-through taxation, which means its income is placed onto the owner’s tax return for that year instead of being taxed at a separate business level. This arrangement usually results in more advantageous tax rates than what would apply if the organization was treated as an S corporation or a C corporation.
- Operating as an LLC provides you with greater control over your business because there are fewer restrictions on how it can be managed. You can select any number of managers to oversee its operations – including yourself – and it doesn’t have to fall into line with other shareholders who might want to use their voting power to take control over its corporate direction.
- Operating as an LLC restricts your ability to raise capital beyond what you could attract from the company’s original founders and financial stakeholders (limited partners). This is because any money invested in an LLC by people who are not “active participants” in its daily operations can be treated as passive income, which means it’ll be taxed at a much higher rate than if it were viewed as an equity investment.
- An LLC has to file the same kind of formal annual reports with your state that most other forms of corporations require, which can run into extra expenses if you’re operating on a tight budget.
What Is a Nonprofit?
A nonprofit is technically any association that’s not formed a for-profit business.
This means it can be a club or group of people who regularly meet up and share their hobbies or an educational institution with the goal of supporting students.
But when you hear about nonprofit organizations in the business world usually what you’re referring to are public charities, also known as 501(c)(3) organizations.
These groups enjoy tax-exempt status under section 501(c)(3) of the Internal Revenue Code (the “Code”).
They serve an important social role by operating exclusively to support their charitable mission, even though they may receive income from many different sources.
Pros and Cons of Nonprofits
- The most important perk of running a nonprofit is that you’re allowed to raise money in the form of tax-deductible contributions under section 501(c)(3) of the Code. Because of this designation, donors can deduct their gifts from their personal income taxes, which makes it easier for nonprofits to attract philanthropic support than if they were taxed like an ordinary business. What’s more, if your organization chooses to apply for regional or state tax-exempt status beyond what it gains at the federal level a federal tax exemption, those exemptions will also be considered “portable” if you move your business to another state.
- A nonprofit is often referred to as a “tax-exempt entity” because they fall under sections 501(c)3, (c)4, or (c)6 of the Internal Revenue Code.
- The second significant benefit of running a nonprofit is that you’re allowed to receive tax-deductible in-kind contributions from donors. This means instead of making a cash donation your supporters can contribute goods or services, which will pass through their company’s balance sheet and be deducted at the value they have assigned. It helps especially when it comes to attracting talent to work for your group since you’ll be able to offer them generous benefits packages without worrying about the IRS disallowing these perks as unreasonably excessive compensation.
- Nonprofit corporations are subject to many of the same legal compliance requirements that other business forms have to follow, such as registering with federal and state governments and filing annual reports with all entities from which they accept funding. These procedures can be time-consuming and expensive and having to worry about them distracts your group from its chief mission of serving the public interest.
- Nonprofits are also often subject to additional reporting requirements that for-profit businesses aren’t beholden to follow. This is because they must publicly disclose any financial relationships they have with donors who give over a certain threshold amount as well as file Form 990 tax returns, which contain company information broken down by section and subsection – something that plenty of small nonprofits would prefer not to deal with.
Similarities and Differences Between an LLC and Nonprofit
Limited liability company (LLC) and 501(c)(3) nonprofit share the goal of serving the public interest, but their structures and distributions requirements are very different.
I. An LLC is a form of business that’s easy to create with just a few pieces of paper at your local state agency or online through legalzoom.com.
a) You can set up an LLC in any state, regardless of where it does business.
b) It has an unlimited life span and can include one or many LLC members in its organizational structure.
c) Profits made by an LLC are taxed as regular income on the personal tax returns of its owners (called “members” when talking about an LLC), so you’ll only need to file taxes once per year!
II. A nonprofit must be incorporated under state law, which means you’ll need to file formal paperwork (usually through your Secretary of State’s office) and pay a filing fee.
a) These fees can be expensive depending on where you’re located, but most states do allow you to recoup them by using tax-exempt bonds that require the nonprofit to pay interest rates above its average cost of borrowing money.
b) While most people think it takes extra time and effort to create a nonprofit, the truth is it usually only takes between 3-4 months from start to finish before they receive their official approval letter in the mail.
c) However, creating an international not-for-profit organization like WWF or UNICEF can take up to two years due to additional approvals required at both the state and federal levels.
Purpose of a Nonprofit and LLC
Nonprofit organization has no shareholders since all profits must go back into the organization to help it achieve its mission.
One of the largest differences between an LLC and a nonprofit is the relationship these companies have with their members.
Low-profit LLC and Nonprofit
LLC can fail to make a profit, and it can be taxed as if it were regular income for all of its members. This is one reason why many business owners prefer to leave LLCs as pass-through entities so they can avoid paying taxes on money that has yet to be earned!
On the other hand, nonprofits are exempt from paying federal income tax because all monies collected must go back into helping the organization achieve its mission.
How LLCs and Nonprofits Are Taxed
1. Unlike a traditional C-corporation, limited liability companies are considered to be “pass-through” entities which means the business exists to serve its members and their profits or losses will pass through its balance sheet.
The bottom line of an LLC’s financial statement is taxed as income at the personal tax rates on each member’s individual federal income tax forms.
a) For example, if you earned $100,000 in net income on your Schedule C business form during the year, this would be passed through to you personally and added on top of any other taxable income that may appear elsewhere on your 1040.
2. For nonprofits, all money they receive must go towards keeping their organization running and achieving its mission statement.
a) It’s important to note that donors can’t earmark their donations for specific programs or projects unless they meet the legal definition of being classified as an “expendable endowment.”
b) When someone donates to a nonprofit, it gives them no benefits other than knowing their contributions are going towards something bigger than themselves.
c) Nonprofits also have another type of fundraising tool called an “unrestricted endowment fund” where the donor specifies that this particular donation is used at the discretion of the organization’s leadership team.
This type of fund decreases the amount of money spent on fundraising because all unrestricted funds must have a minimum balance of $5,000 in order to be monitored by the IRS.
Distribution of Profits between an LLC and Nonprofit
- When it comes to making decisions about how to distribute money between the members of an LLC, the general rule is that everyone must agree on any one possible scenario.
- If they can’t reach a consensus, then the managers of the LLC will usually vote on how profits are allocated. This decision should be included in the organization’s operating agreement in order to avoid potential disputes in case someone later decides they would like their share increased or decreased.
- On the other hand, when it comes to nonprofits, there are very specific rules set out by both state and federal law that say exactly how charitable donations can be spent once they’re earned.
However, even though this sounds pretty straightforward there are still many grey areas where nonprofits learn to make decisions by interpreting the rules more loosely.
How Can I Incorporate a Nonprofit?
The first step is to contact the Secretary of State office for your state and request a copy of their nonprofit corporation package.
Each state has different fees and laws about nonprofit incorporation, so it’s important to check with your state before you begin filing any paperwork.
Can Nonprofits Register as an LLC?
No, the IRS specifically prohibits the practice of nonprofits registering as LLCs because there is no substantive difference between the two types of business entities.
If you’re looking to create a business in order to make money, an LLC is probably your best bet.
However, if you want your company to focus primarily on doing good for others and helping them in whatever way possible, then a nonprofit might be more up your alley.