Choosing an entity type as a legal structure for your future business, you first need to consider your business goals and aspirations since legal entities differ in tax methods and protections they offer. If you select between an LLC and a nonprofit, both come up with a limited liability benefit. Yet, you should know that the difference between them is much deeper than simply earning money or not. Having a lot in common, these two entities have different goals and operate for different purposes. To find out all ins and outs of these legal structures and see how they stack up, keep on reading our comparative review.
Nonprofit vs LLC: Definitions
A limited liability company (LLC) is a relatively new legal structure initiated back in the 1970s to match the needs of the fast-changing business environment. Since then, it has gained huge popularity thanks to its amazing flexibility. An LLC is a combination structure mixing the best of all worlds. It boasts a simple management structure of partnerships, pass-through taxation of sole proprietorships, and the liability protection of corporations. All of this makes a well-balanced legal formula adaptable to many business situations and suitable for all business sizes. Traditionally, LLCs gain profit, which is further distributed between the company members or can remain in the company to maintain further growth.
A nonprofit is an organization that is set up rather for serving public interests and higher missions than simply generating profit for its owners. To maintain the good intentions of such ventures, the IRS treats nonprofits as tax-exempt entities. Since usually, the income of nonprofits is voluntary donations and financial aid from sponsors and patrons, it is not taxable, and those contributions commonly appear tax-deductible for their makers. However, to retain that tax-free status, all business assets and revenues should be either reinvested into the company, used for public needs, or distributed to other nonprofits. Otherwise, the IRS will deprive a nonprofit of that privileged status.
All in all, there are 27 types of nonprofit organizations distinguished by the IRS. The biggest categories are charitable organizations, private foundations, and religious organizations. Other types cover welfare and healthcare organizations, social and educational centers, focused groups, etc.
Nonprofit vs LLC: Pros and Cons
Certainly enough, each of these entity types has its values and downsides that are good for some business scenarios and not appropriate for others. To better understand nonprofits and LLCs, let’s take a closer look at their strong sides and weaknesses they have.
Pros and Cons of LLCs
Personal Asset Protection
Similar to corporations, LLCs ensure secure protection for personal members’ assets, property, and funds against business liabilities and lawsuits. It’s the benefit of a “corporate veil” or limited liability brought to LLCs from corporations.
The LLC structure allows passing business profits and losses to the personal tax returns of the company owners, thus avoiding federal taxes and the burden of dual taxation. On top of that, LLCs can elect to be taxed as corporations. Still retaining its legal status, an LLC can apply for an S-Corp or C-Corp tax status to match certain business needs.
Easy Startup and Maintenance
Establishing a solid legal framework, LLCs are fairly easy to register and maintain. Neither the filing process nor the further upkeep involves many paperwork routines and formalities.
LLC members could choose to manage their business by themselves and split the managing and control roles. Or they can function as independent investors and hire third-party professionals for ongoing management and daily operations. There is no law requirement for either scenario. It’s solely the LLC members’ choice.
Varying Formation Requirements
Since LLCs are formed under the state statutes, filing rules might vary by state. Though basic procedures are pretty much the same, some states have certain restrictions or special requirements in place that might limit your business or conflict with your business goals in a way.
Lower Fundraising Potential
Despite being a reliable legal structure, an LLC offers fewer protections than a corporation that makes them less attractive for third-party investors. Unlike corporations, LLCs can’t issue stock, and their major source of capital financing is bank loans.
LLC members are considered self-employed by default. They cannot work in their own company as regular employees, hence, they are exposed to self-employment tax payments. Given that members pay income taxes on business profit distributions, the total tax amount can appear quite high.
Pros and Cons of Nonprofits
Tax exemption is the biggest benefit of nonprofits. They don’t pay federal, state, and local taxes on funds they get as donations, charitable contributions, or sponsor financing. On the other hand, supporters and benefactors can report those contributions as tax-deductible expenses.
Normally formed as corporations, nonprofits benefit from limited liability and other protections granted by a corporate legal structure. Thus, nonprofit founders can deliver to their charitable mission while being legally separate from the organization.
Eligibility for Obtaining Grants
Nonprofits are entitled to get grants from both government agencies and authorities and private foundations. There are some state grants available only to charities. Meanwhile, private companies are eager to make donations since they allow cutting down their own taxes.
Most nonprofits are devoted to a certain mission, initiative, or cause that strongly resonates with public interest or caters to the needs of a specific social group or category. For this reason, nonprofits usually get wide public support.
Complex and Pricey Formation
It will take you quite a lot of time and effort to duly register a nonprofit organization. Incorporation alone is rather a complex process. Then, you’ll have to apply for the tax exemption with the IRS. These processes also entangle state fees, and you might need a lawyer’s assistance to get everything right, which is also payable.
As a tax-exempt entity, a nonprofit organization will have to keep records of all its transactions and keep a close eye on state and IRS filings. That’s not to mention documents you’ll have to collect to solicit for a grant.
Unlike for-profit entities, nonprofits are not only managed by their creators but also strictly governed by state laws and regulations. Besides, nonprofit organizations should closely observe the provisions of their incorporation documents and corporate bylaws. In some states, nonprofits are even required to have several managing directors to avoid any unauthorized actions and authority misuse.
IRS and Public Scrutiny
Nonprofits are exposed to regular IRS audits to prove their tax-exempt status. Should the IRS reveal even minor violations, they can take away this status immediately and issue fines. At the same time, financial statements and filing reports of nonprofits are publicly available so that anyone could check those documents at any time.
Dedication to a Single Purpose
Nonprofits should consistently maintain a single purpose that was specified during incorporation. Hence, such organizations are usually devoted to one specific mission.
Nonprofit vs LLC: Similarities and Differences
Nonprofits and LLCs have much in common, especially at the level of a legal structure. Thus, both entities are independent legal persons separated from their owners. As such, they should be officially filed with the state to get formed and match all state rules and requirements to maintain the business compliance afterward. Besides, both entities offer limited liability protection to their owners keeping their personal assets shielded from business debts and lawsuits.
To continue, both LLCs and nonprofits can generate income. While LLCs are initially created for earning money, nonprofits could also bring revenue via providing some services or selling some products in addition to receiving donations and contributions.
To run their companies, both entities should register EIN numbers and can hire employees and pay salaries. Notably, in this case, nonprofits are also obliged to pay wage-related taxes.
The major spheres where LLCs and nonprofits are different cover the ways they generate profit, further profit distribution, taxes, and management structure. While LLCs are engaged in commercial activities to earn money, the main source of income for nonprofits is gifts and donations. The profits companies gain are distributed differently as well. LLCs distribute their profits to business owners while nonprofits are obliged to reinvest their revenues to the company or give it to public needs.
When it comes to taxes, this is where the biggest difference between these two entity types occurs. Though distinguished by a flexible taxation system, LLCs must pay taxes anyway while nonprofits have tax-exempt status.
Finally, LLCs are established by members, each having a share in the company and entitled to a part of the profit proportional to their share. The company can be managed either by the owners or by hired managers. Nonprofits, on the other hand, are run by the stakeholders. Those could be either company founders and employees or beneficiaries and even the general public. Day-to-day operations are controlled by the board of directors, yet, they don’t get any profit.
Nonprofit vs LLC: Final Decision
To sum it all up, a limited liability company is a good choice for you, if:
- You strive to create a partnership venture with a solid legal framework;
- You seek to earn money and are ready to pay taxes on incomes;
- You are not going to issue stock and plan to raise funds via banks credits;
- You want to separate your business and personal assets and make sure your property will be not affected by business problems.
In the meantime, a nonprofit is a reasonable alternative for anyone who:
- Seeks to deliver to a higher mission or cause and serve some important public needs and interests;
- Wants to contribute to social welfare or provide help to certain socially vulnerable groups of people;
- Needs a reliable legal structure that will let realize those goals while bringing efficient legal protection to the company founders.