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LLC vs. Nonprofit: Your Guide to Making the Right Decision in 2021

LLC vs. Nonprofit: Your Guide to Making the Right Decision in 2021

woman standing into front of building thinking about what kind of business to start

You might think that operating as either a limited liability company (LLC) or a nonprofit is simply a choice of whether you want to make money or not, but it’s not quite as simple as that. We’ll break down some of the main factors you’ll want to consider so you can make the best decision for your business.

LLCs vs. Nonprofit: What They Have in Common

Before we get into the main differences between the two types of organizations, let’s explore the principles that apply to both of them.

Both Separate Legal Entities

This means both LLCs and nonprofits exist separately from the owners from a legal perspective. You will need to create and file relevant paperwork with state and federal authorities to create your LLC or nonprofit.

Both Provide Liability Protection

Liability protection comes from the organization being legally separate from you. This means that if someone tries to take legal action against the LLC or nonprofit, your personal assets and finances would not be liable and cannot be seized. LLCs get this liability protection when they are formed; nonprofits need to form as a “nonprofit corporation.”

Both Can Generate Revenue

Both types of organizations can sell products and services. For an LLC, that’s whatever the main business offering is. For nonprofits, that revenue is typically in addition to gifts and donations. For example, a nonprofit humane society gets most of its income from donations but can also charge adoption fees for animals and markups on pet supplies that they sell.

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Both Can Pay Salaries

LLCs and nonprofits are both required to pay salaries to workers on payroll. For a nonprofit, that will include all salaried staff. For an LLC, this is likely to be everyone but the owners. Employees of both types of organizations will also pay taxes on wages.

Both Need to Comply with Federal and State Rules

There’s an administrative overhead to running both types of organizations, including keeping good records, filing the correct paperwork on a regular basis and ensuring you have the right licenses and permits in place. Due to the tax-exempt status of nonprofits, the overhead is a little more than for an LLC.

Both Must Have Employer Identification Numbers

An EIN is a tax identification number provided by the IRS that you use in correspondence and when filing tax returns. Incfile can obtain an EIN on your behalf.

LLCs vs. Nonprofits: The Main Differences

Although there are many similarities, there are also some critical differences.

LLCs and Nonprofits Generate Income in Different Ways

LLCs generate revenue by charging more for their products and services than it costs to provide them. Nonprofits generate revenue through gifts, donations and grants.

LLCs Generate and Distribute Profits, Nonprofits Do Not

The key difference between LLCs and nonprofits is what they do with the money they generate:

  • LLCs can choose to distribute profits from their business operations, products and services to their owners.
  • Nonprofits must use revenue after operating expenses and employee salaries to carry out their mission.

While a humane society can sell pet products and supplies, any revenue received from doing so cannot be taken out of the organization as profit — instead, it is used to expand the good work of the organization.

LLCs Pay Taxes on All Profits They Generate, Nonprofits Do Not

LLC owners will typically pay self-employment, federal and state taxes on the money they take out of the business. Because nonprofits are not generating a profit, they are typically exempt from these types of taxes.

To get and achieve tax-exempt status, a nonprofit must file a 501(c)(3) with the IRS and meet strict compliance and regulations. Donors to a registered nonprofit can show donations as tax-deductible.

LLC and Nonprofit Ownership and Management Are Different

LLCs are owned by “members” or “managers.” Each of these owners has a particular stake in the LLC and is entitled to a certain share of the profits, which are taxable. The rules governing an LLC are defined in its Operating Agreement. An LLC is not required to have a separate board of directors.

Nonprofits do not have private owners. Instead, they are run by “stakeholders” who can be directors, employees, beneficiaries or the public. Nonprofits are typically managed by a separate board of directors or voting members who cannot profit from the organization. Nonprofits operate according to a “charter.”

Making the Final Decision Between an LLC or a Nonprofit

LLCs are ideal if you:

  • Make a profit from your business, which you will pay tax on
  • Have an ownership structure run by members or managers of the LLC
  • Are raising capital through loans or financing
  • Do not intend to issue stock or shares of any kind
  • Want standard limited liability protection
  • Manage your LLC through an Operating Agreement
  • Can follow light compliance and regulation requirements

Nonprofit corporations are ideal if you:

  • Limit the money that anyone in the business makes to reasonable compensation
  • Dedicate other money earned by the business to business operations, nonprofit work and other initiatives
  • Want to get beneficial tax treatment from the IRS and your state’s Department of Revenue following 501(c)(3) approval
  • Get limited liability protection if you form as a nonprofit corporation
  • Will not have private owners, but will instead be run by stakeholders who can be directors, employees or members of the public
  • Will appoint a board of directors or voting members
  • Will put nonprofit bylaws in place and have meeting minutes
  • Expect to raise capital through donations, grants and gifts
  • Will not issue stocks or shares
  • Can follow moderate compliance and regulation requirements

Want to get started? Incfile can partner with you to form your LLC or nonprofit.