The limited liability company (“LLC”) is popular with both companies and individuals looking to form new businesses and acquire property due to it combining many of the advantages of both corporations and partnerships. LLCs, when properly managed, shield owners from liability for the debts, obligations, and other liabilities of the LLC. A corporation may create separate LLCs for subsidiaries in order to protect other parts of the company, or an individual may establish an LLC to purchase and manage investment properties. When an LLC is wholly owned by a single member, the LLC is treated as a “disregarded entity” for most federal tax purposes – this means that the owner may report the LLC’s financial activity on the owner’s tax return without the need to file a separate return for the LLC. This significantly reduces the owner’s time and money spent on preparing tax returns while still offering the liability protections afforded by the LLC structure.
Nonprofits, like for-profit companies, face potential liability related to their activities and the property that they own. In many cases, a wholly-owned, single-member LLC (“SMLLC”) can protect the parent entity by separating certain activities, such as child-care services or the management and rental of income properties, that inherently carry a degree of risk. The SMLLC is especially useful for handling real property donations where potential environmental liabilities are not apparent, and where the parent organization wishes to exclude itself from the property’s chain of title to avoid future obligations.
A SMLLC owned by a nonprofit, tax-exempt organization does not need to file its own application for exempt status. Instead, the SMLLC’s actions will be treated as if they were the actions of the parent organization. The parent organization should report the SMLLC’s activities on its information return (such as a Form 990) filed with the IRS. This reflects the fact that the SMLLC is a “disregarded entity” in the same way as if its single member were a for-profit company or an individual. In 2012, the IRS confirmed that a donor may deduct donations to the SMLLC where the single owner of the SMLLC is a charitable organization.
While the SMLLC structure affords the parent organization a significant benefit in terms of liability protections, a nonprofit should avoid taking advantage of the SMLLC in a manner that could jeopardize the nonprofit’s own tax exemption or create tax liability. Because the SMLLC is treated essentially as a branch or division of the parent organization, the SMLLC must avoid actions that are inconsistent with the nonprofit’s charitable purpose. This means that the same rules against private inurement apply to the SMLLC, and the SMLLC cannot engage in lobbying or campaigning for a particular party or candidate. Additionally, the SMLLC cannot engage in activities that have a substantial nonexempt purpose and which may generate excessive unrelated business income (“UBI”).
Even if the amount of UBI generated by the SMLLC is not substantial enough to jeopardize the parent organization’s tax exemption, the UBI must still be reported and the organization must pay tax on that amount. The parent organization will need to report the information when filing its annual information return. However, passive income from rental properties, as well as the proceeds from the disposition of investment property, do not constitute UBI. Therefore, many nonprofits may benefit from forming a SMLLC subsidiary to receive and manage real property donations. These subsidiaries will protect other assets of the nonprofit from any liability associated with the donated property while still permitting the donor to take a tax deduction on the donated property.