Nonprofit organizations sometimes consider forming a Limited Liability Company (LLC) as a way to generate revenue while limiting liability. As an example, your nonprofit wants to establish an LLC to operate a coffee shop. While this can be a viable option, there are important legal and tax implications to consider.
Can a Nonprofit Own an LLC?
Yes, a nonprofit can establish an LLC, but the implications depend on whether the LLC is:
A Disregarded Entity – If the nonprofit is the sole owner of the LLC, the IRS treats the LLC as part of the nonprofit (unless it elects otherwise). The nonprofit is responsible for the LLC’s financial and tax reporting.
A Taxable Subsidiary – If the LLC engages in business activities unrelated to the nonprofit’s mission, it may be considered a taxable entity, meaning it must file its own tax return and pay taxes.
Key Legal and Tax Considerations
Unrelated Business Income Tax (UBIT)
If the LLC’s coffee shop is not substantially related to the nonprofit’s exempt purpose, profits may be subject to Unrelated Business Income Tax (UBIT).
If the shop is operated primarily by volunteers or provides job training in line with the nonprofit’s mission, it may avoid UBIT.
Maintaining Tax-Exempt Status
The nonprofit must ensure that the LLC’s activities do not jeopardize its 501(c)(3) status.
The IRS may scrutinize whether the LLC is benefiting private individuals or diverting too much focus from the nonprofit’s exempt mission.
Legal Liability Protection
An LLC can shield the nonprofit from liability associated with the business. However, if the nonprofit does not maintain proper separation (e.g., separate bank accounts and governance structures), courts may disregard the LLC’s limited liability.
State Laws Vary
Some states have restrictions on nonprofit ownership of LLCs or impose additional requirements, such as having the LLC’s purpose align with the nonprofit’s mission.
Best Practices for a Nonprofit-Owned LLC
Ensure the LLC’s purpose aligns with the nonprofit’s mission, if possible.
Keep finances and governance structures separate to maintain liability protection.
Consider applying for a separate EIN and tracking revenue independently.
If UBIT is a concern, explore ways to align the business with the nonprofit’s charitable purpose.
Consult with legal and tax professionals to ensure compliance with IRS rules and state laws.
Bottom Line
A nonprofit can own an LLC, but careful planning is required to ensure compliance with tax and legal regulations. If the LLC operates in alignment with the nonprofit’s mission, it may avoid UBIT and maintain tax-exempt status. Otherwise, the nonprofit should prepare for potential tax liabilities and reporting obligations.