Written by attorney Benjamin Flavin | May 3, 2011

Hybrid Organizations: Not-For-Profit Organizations and Limited Liability Companies

There has been much debate on the benefit of blending a not-for-profit mission with a for-profit bottom line. Traditionally not-for-profit organizations have had faced a daunting challenge of raising money through gifts, whether those gifts are through members, government agencies or foundations. Because the difficulty of fundraising, many non-profits have attempted to include a for-profit enterprise to supplement the charitable organization's mission. Commonly, this takes the form of a LLC owned and managed at least in part by the non-profit corporation. Revenue from the for-profit LLC is transferred back to the non-profit. This may be acceptable under the IRS guidelines for a 501(c)(3) federal income tax exempt organization if all of the LLC members are tax exempt organizations. Any income the LLC makes would pass through the LLC and be sheltered under the not-for-profit's exempt status. The IRS states that a "domestic LLC with a single owner or member is disregarded for federal tax purposes." This is true for whether the LLC is an exempt organization or not. If the single member is an exempt organization, that organization's exempt status will not be jeopardized "merely because the organizational documents do not contain specific language limiting the LLC's purposes to more or more exempt purposes." The not-for-profit board of directors must insure the organization's mission and public purpose is followed. The organization is not permitted to engage in activities that do not adhere to the public purpose and mission detailed in its certificate of incorporation. This purpose is the foundation upon which the IRS granted its federal income tax, federal unemployment tax and other federal taxes as applicable. If the LLC has the same mission and conducts activities that adhere directly to the not-for-profit's mission there is no clear advantage to engage in the expense and recordkeeping of forming disregarded business association. However, a separate LLC, either wholly owned by the nonprofit, or having separate members may return money to the nonprofit in the form of the donation. The LLC's income will be subject to all applicable taxes, and the non-profit must ensure the LLC's activities are in line with the charitable purposes prescribed in the not-for-profit's certificate of incorporation. Once other members are involved this becomes more difficult, especially when other members are investors looking for a profit. Many questions are raised in this sort of hybrid enterprise: what part of the revenue is returned to the nonprofit? If the venture loses money who is supports the LLC? How does a nonprofit negotiate the boundaries of receiving the income without compromising its public purpose? Can directors receive a dividend from the LLC if they are individual members of the LLC? These issues are mostly unresolved and deserve serious consideration before a nonprofit enters into a for-profit venture.

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