Because of the tax choices available to owners for pass-through profits, LLCs are ineligible for tax-exempt, or nonprofit, status.
Is it possible for an LLC to establish a nonprofit subsidiary? Because of the tax choices available to owners for pass-through profits, LLCs are ineligible for tax-exempt, or nonprofit, status. However, there is a possible solution to this regulation. If the LLC is completely owned by a parent company, the parent corporation might apply for nonprofit status and pass it on to the LLC.
Because LLCs incorporate a lot of the benefits of both partnerships and corporations, they appeal to both people and businesses wishing to establish a new firm. When correctly managed, an LLC can protect its members from personal accountability for the company’s commitments and debts. Corporations may form separate LLCs for subsidiaries to safeguard other areas of the company, or individuals can form an LLC to acquire and manage investment property.
The IRS considers an LLC that is completely owned by one person to be a disregarded company. The LLC’s owner is not obliged to file an individual federal tax return for the company and may record the firm’s financial activity on their personal tax return. This reduces the LLC owner’s tax-return expenses and time while maintaining providing liability protections under the LLC structure.
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Do Nonprofit Organizations Require LLC Subsidiaries?
Nonprofits, like for-profits, are susceptible to possible responsibility for their business actions and any property they hold. A single-member LLC (SMLLC) may safeguard the parent organisation in a variety of circumstances by splitting off certain operations that are inherently risky. Income property management and rents, as well as child care services, are examples of activities.
SMLLCs are very effective in circumstances involving real estate contributions where there may be unknown environmental liabilities or where the parent organisation wishes to guarantee that it is removed from the chain of ownership to avoid any future duties. If a nonprofit owns an SMLLC, the organisation does not need to submit a second application to achieve exempt status. The SMLLC’s acts will be considered as if they were part of the parent nonprofit organisation.
Although the SMLLC structure affords the parent nonprofit organisation with significant advantages in terms of liability property, it should not use the subsidiary in a manner that jeopardises its own nonprofit exemption or creates extra tax obligations. Because the SMLLC is still recognised as a subsidiary or branch of the nonprofit, it must avoid conduct that might be seen as adverse to the benevolent objective of the parent organisation. As an example:
The SMLLC cannot engage in activity that might have a significant nonexempt purpose, such as work that would generate excessive UBI, or unrelated commercial revenue.
The SMLLC is not permitted to advocate or lobby for a certain political party or candidate.
Even if the UBI is not sufficient to jeopardise the nonexempt status, it must be reported to the IRS and the parent organisation must pay tax on it. Passive income, such as rental property income, does not qualify for UBI. This is why, if a charity receives real estate contributions, it may benefit from an SMLLC subsidiary. It may shield the nonprofit’s other assets from any liabilities arising from donated property.
Consider include the SMLLC’s activities in your IRS information return, such as Form 990. This will show the SMLLC as a disregarded entity, similar to how it would if it were a subsidiary of a for-profit firm. The IRS confirmed in 2012 that payments to an SMLLC may be deducted where the only owner of the LLC is a charity.
Tips for Keeping Separate Entities
The IRS provides guidance on how to keep your for-profit subsidiary’s identity separate:
Each organisation should have its own board of directors.
Maintain separate books and records for each organisation.
Each firm should have its own set of personnel.
Most NGOs cannot afford to establish a distinct staff for the subsidiary, which is reasonable. Some administrative responsibilities, such as space leasing or payroll, may be handled by the parent organisation without danger of punishment if done appropriately.
When negotiating a bargain, utilise fair market value to determine the value of services or transactions. If the purchase includes a high-value property, an independent evaluation should be performed. Make a point of getting any agreements in writing. Transactions should be authorised by both the parent and the subsidiary, and payments should be meticulously recorded.
Finally, keep an eye out for board overlap. It is advised to form a smaller board of directors comprised of outside directors.