How to Form an LLC for Nonprofit (Step-by-Step)

Serious question: do you need an LLC for a nonprofit organization?

So, you’re ready to make a difference in the world and launch a nonprofit?

That’s fantastic.

But before diving headfirst into your mission, you might ask yourself the important question: Should I form an LLC for my nonprofit?

The answer is a resounding yes for many aspiring nonprofit leaders.

An LLC, or Limited Liability Company, can be an excellent choice for protecting your assets while giving you the flexibility to run your organization as you envision it.

In this guide, I will walk you through the step-by-step process of forming an LLC for your nonprofit.

Can an LLC Be a Nonprofit?

Yes, an LLC can technically support nonprofit activities, but it cannot be a nonprofit.

Let me break this down for you:

An LLC is usually set up to make a profit; its owners (called members) share in those profits. On the other hand, nonprofits exist to serve a public or charitable purpose, and any money they make has to go back into supporting that mission—NOT into anyone’s pocket.

But here’s where it gets interesting: a nonprofit organization can own or form an LLC to handle specific activities.

For example, a nonprofit might create an LLC to run a bookstore or café that raises money for the organization’s cause. In this case, the LLC is for-profit but owned by the nonprofit, and the profits go back to support the nonprofit’s mission.

Imagine a charity that builds houses for needy people (like Habitat for Humanity). They could set up an LLC to sell construction materials or even services. The LLC makes money, but instead of the owners pocketing the profits, all the earnings go right back to the charity to build more homes.

So, while an LLC can’t be a traditional nonprofit, it can work alongside or under a nonprofit to achieve its mission. The key is that the profits must be used for charitable purposes, not personal gain.

Do You Need an LLC for a Nonprofit Organization?

No, you don’t need an LLC for a nonprofit organization. Most nonprofits are structured as nonprofit corporations rather than LLCs.

Let’s break it down bit by bit:

A nonprofit corporation is a specific legal entity created to serve a public or charitable purpose. It comes with tax benefits. For instance, nonprofits can apply for 501(c)(3) status, which makes them tax-exempt and allows donors to make tax-deductible contributions.

This status is a major reason why most nonprofits choose to incorporate as a nonprofit corporation rather than an LLC.

On the other hand, an LLC is typically designed for for-profit businesses, where the owners (called members) share profits. It doesn’t naturally fit the nonprofit model because an LLC’s main goal is profit distribution, while a nonprofit’s goal is to reinvest any earnings into its mission.

That said, a nonprofit can use an LLC for certain business activities, as I mentioned earlier. But if your main goal is to start a traditional nonprofit that serves a public or charitable cause, you’ll likely want to create a nonprofit corporation instead.

Simply put, a nonprofit corporation is the better fit if you’re considering launching a nonprofit to serve a community or cause. An LLC can play a role, but it’s not required.

Why do Nonprofits Typically Use LLCs?

Forming a nonprofit LLC can provide numerous benefits that enhance your organization and its effectiveness.

Let’s explore some of the key reasons why this choice might be right for you.

Liability Protection for the Nonprofit

Forming an LLC provides liability protection by shielding the nonprofit from debts or lawsuits related to the LLC’s activities. Even single-member LLCs offer this protection, but operational formalities like separate bank accounts and operating agreements must be observed. Courts may “pierce the veil,” removing the LLC’s protection if ignored.

Independence in Day-to-Day Operations

An LLC allows nonprofits to delegate program management while maintaining oversight. This separation grants the LLC’s management team autonomy for day-to-day decisions, like executing contracts and managing expenses. The nonprofit retains control but reduces direct involvement in daily operations.

Brand Independence for Special Programs

Creating an LLC allows nonprofits to separate certain activities under a distinct brand, which can enhance credibility. Programs like research or events can benefit from being seen as independent rather than tightly aligned with the parent organization. This separation helps avoid potential conflicts with the nonprofit’s identity and builds a unique identity for specific initiatives.

Pass-through Taxation

An LLC offers pass-through taxation, where profits and losses are reported directly by the owner—in this case, the nonprofit. This structure avoids double taxation, simplifying the tax process for nonprofits managing LLC subsidiaries. The income flows directly to the nonprofit, maintaining its tax-exempt status. It streamlines the organization’s tax responsibilities.

Easier Fundraising Opportunities

Forming an LLC can open doors to various fundraising opportunities, such as grants and partnerships. Many foundations and donors prefer to support registered entities, and having an LLC can make your nonprofit more appealing to potential contributors looking to support legitimate, organized efforts.

Starting a Nonprofit LLC: Step-by-Step Guide

Starting a nonprofit LLC involves a unique set of steps combining elements of traditional LLCs and nonprofit corporations.

Here’s a detailed guide to help you navigate forming your nonprofit LLC:

1. Choose a State to Register Your Nonprofit LLC

The first step in forming your nonprofit LLC is selecting the state where you want to register. Each state has unique laws, benefits, and requirements for nonprofit LLCs, so it’s crucial to consider factors like local tax laws, regulatory environment, and even the community you aim to serve. Picking a state that aligns with your mission can set a strong foundation for your organization.

2. Choose a Name for Your Nonprofit LLC

Select a unique name that reflects the mission and purpose of your nonprofit activities. The name must comply with your state’s naming rules for LLCs and should not be identical to any existing entity names. Consider including words highlighting the organization’s charitable nature, and check for domain name availability if you plan to create a website.

3. Designate a Registered Agent

Every nonprofit LLC must have a registered agent—a person or business entity designated to receive legal documents on behalf of the organization.

This can be a state resident or a registered agent service. The registered agent plays a vital role in maintaining compliance, so choose someone reliable who can ensure that important documents are handled promptly.

4. File Your Articles of Organization

The Articles of Organization is the official document that registers your LLC with the state. In the document, you must specify that the LLC is formed for nonprofit purposes and that any profits will not be distributed to members. Include information about the LLC’s management structure and whether the LLC is member-managed or manager-managed.

5. Obtain an Employer Identification Number (EIN)

You must apply for an EIN from the IRS, which is necessary for filing taxes, opening a business bank account, and hiring employees. The EIN will serve as your LLC’s federal tax ID number.

6. Consider an Operating Agreement (Optional)

This document outlines how the LLC will be managed, its goals, and how profits will be handled. For a nonprofit LLC, the Operating Agreement should clearly state that profits will be used for the organization’s charitable purpose and not distributed to members or owners.

7. Apply for 501(c)(3) Tax-Exempt Status (Optional)

A nonprofit LLC cannot apply for 501(c)(3) status unless wholly owned by a tax-exempt nonprofit corporation.

To qualify, the LLC must have the parent nonprofit as its sole member, operate exclusively for charitable purposes, and ensure all profits support its mission.

Alternatively, the LLC can operate without tax-exempt status and pay taxes as a regular LLC, but it must still use profits for charitable purposes.

8. Open a Separate Bank Account

Open a business bank account in the LLC’s name to manage its finances separately from personal funds. This ensures that all revenue is properly tracked and used for the nonprofit’s mission.

Additional Resources and Other Considerations for Nonprofit LLC Owners

Utilize LLC Formation Services to Simplify the Process

Consider using an LLC formation service to handle the complexities of starting your nonprofit. These services can assist with paperwork, compliance, and filing fees, allowing you to focus on your mission.

Companies like Northwest Registered Agent offer tailored services for nonprofit LLCs, helping you easily navigate state regulations.

Maintain Ongoing Compliance

Once your nonprofit is formed, you must file annual reports, maintain detailed financial records, and submit tax documents such as IRS Form 990 to preserve your nonprofit status.

Draft Bylaws for Nonprofit LLCs

Bylaws are the internal rules governing your nonprofit LLC’s operations. These should include details about your board structure, meetings, voting procedures, and other operational protocols. While bylaws aren’t filed with the state, they are crucial for guiding your nonprofit’s day-to-day management.

Submit a Beneficial Ownership Information Report (BOI)

Starting January 1, 2024, nonprofit LLCs are generally required to file a Beneficial Ownership Information (BOI) report under the Corporate Transparency Act (CTA) unless they qualify for specific exemptions. Most nonprofits recognized under sections like 501(c)(3) and 501(c)(4) are exempt from filing, as they fall under the tax-exempt entity exemption.

Ownership and Profit Usage in Nonprofit LLCs

A single nonprofit entity must entirely own a nonprofit LLC to qualify for 501(c)(3) tax-exempt status or operate with a clear charitable mission without seeking such exemption.

Additionally, all profits generated must be reinvested into charitable purposes, with members and owners prohibited from receiving distributions. This highlights the key difference from traditional LLCs that share profits.

Consider Obtaining Insurance for Your Nonprofit LLC

Insurance is an important consideration for any nonprofit LLC. Different types of coverage, such as general liability, directors and officers (D&O) insurance, and property insurance, can protect your organization from unexpected legal and financial risks.

Seek Expert Guidance When Necessary

Navigating the world of nonprofit management can be complex, so don’t hesitate to seek expert guidance. Consulting with attorneys or financial advisors specializing in nonprofit law can provide valuable insights into legal compliance, tax obligations, and best practices for governance.

What is the best state to open an LLC for a Nonprofit?

Choosing the right state for incorporating your nonprofit is crucial, as it can affect tax status and regulatory obligations.

Delaware is a popular option with over 5,500 nonprofits; it allows formation with just one director for a low fee of $89 and has flexible reporting requirements.

Wisconsin is another solid choice. It features a low incorporation fee of $35 and generous tax exemptions for charitable purposes, though it requires three unrelated directors and has stricter reporting rules.

If you want affordability and speed, consider Arizona. It charges only $40 to file, has no registration requirements for fundraising, and processes applications quickly, although you’ll need to publish a Notice of Incorporation in a local newspaper.

Texas offers a robust nonprofit landscape with over 100,000 organizations. The incorporation fee is just $25 but requires three directors and annual reports.

Finally, Nevada stands out for its lack of state income tax and minimal regulations. Incorporating requires only $50 and quick approval; no state business license is needed.

Nonprofit LLC vs. Nonprofit Corporation: Which One Should You Choose?

It’s important to know how each structure operates before choosing between a nonprofit LLC and a nonprofit corporation.

Nonprofit corporations are the common choice for organizations seeking 501(c)(3) tax-exempt status, as they allow for tax exemptions and tax-deductible donations. This structure also makes it easier to secure grants and funding since many foundations prefer or require it.

In contrast, a nonprofit LLC offers more flexibility, especially if you plan to run a social enterprise alongside your charitable activities. It typically involves fewer formalities, such as reduced paperwork and fewer board meetings, making management simpler than a nonprofit corporation.

Frequently Asked Questions

Can members of a nonprofit LLC receive profits?

No, members of a nonprofit LLC cannot receive profits. All profits the LLC generates must be reinvested into the organization to support its charitable mission. This restriction distinguishes nonprofit LLCs from traditional for-profit LLCs, where members typically share profits.

What are the requirements for a nonprofit LLC to qualify for 501(c)(3) status?

To qualify for 501(c)(3) status, a nonprofit LLC must meet specific requirements: wholly owned by a tax-exempt nonprofit corporation, operate exclusively for charitable purposes, and ensure that all profits are used to further the charitable mission.

Can a nonprofit LLC operate without tax-exempt status?

Yes, a nonprofit LLC can operate without tax-exempt status. In this case, it would function similarly to a traditional LLC, paying taxes on its income. However, even without tax-exempt status, the nonprofit LLC must still use its profits for charitable purposes and align its activities with its mission.

What are the disadvantages of forming a nonprofit LLC?

One disadvantage of forming a nonprofit LLC is the potential lack of access to the same level of funding opportunities as nonprofit corporations, which can affect long-term sustainability. Additionally, management flexibility can lead to conflicts among members if not clearly defined in the operating agreement.

What annual fees are associated with a nonprofit LLC?

Annual fees for an LLC can vary depending on the state in which it is registered. Common costs include state filing fees, annual report fees, and potential franchise taxes. Additionally, costs such as legal fees or accounting services may be associated with maintaining compliance.

Can I form a nonprofit LLC in a state different from where my organization is based?

Yes, you can form a nonprofit LLC in a state different from where your organization is based. However, doing so may require registering as a foreign entity in your home state, which can involve additional fees and paperwork. It’s essential to consider the implications of this decision, including tax obligations and compliance with the regulations in both states.

Can a nonprofit LLC engage in business activities?

A nonprofit LLC can engage in business activities, provided these activities align with its charitable mission. The profits from these activities must support the nonprofit’s purpose rather than be distributed to members.

Can I serve as my nonprofit LLC’s registered agent?

You can serve as your LLC’s registered agent, provided you meet your state’s requirements. As a registered agent, you will be responsible for receiving legal documents and official correspondence on behalf of the organization.

Why should I hire an LLC service when I can form my own nonprofit LLC?

Hiring an LLC service can streamline the formation process and ensure compliance with all legal requirements. These services often provide expertise in filing necessary documents, drafting operating agreements, and managing ongoing compliance tasks.

Are permits or licenses required for a nonprofit LLC?

The permits and licenses required for a nonprofit LLC vary based on the nature of its activities and location. Generally, a nonprofit LLC may need a business license, fundraising permits, and any specialized licenses related to its services (such as food service permits for a nonprofit café).