Zana Tomich
Dalton & Tomich, PLC
Dalton & Tomich, PLC
An interesting trend in nonprofit corporate law is more nonprofits considering the benefits of forming a Single-Member LLC (SMLLC) as a wholly owned subsidiary of the nonprofit that can own property, operate a business venture, or manage certain liabilities. This trend is not necessarily driven by funding challenges or threats, nor has there been a recent change in the law. In my experience with faith-based nonprofits, the SMLLC consideration stems chiefly from the fact that nonprofits are becoming more creative in the services they provide, which may be outside of the scope of their original – and tax exempt – mission.
Recent work involves nonprofits that have formed SMLLCs to operate a daycare, a thrift store, or a podcast, and to house other “for profit” type activities. The SMLLC allows nonprofit corporations to keep income-producing ventures such as these separate to insulate themselves from both legal liability and from jeopardizing their tax-exempt status.
As nonprofits grow, so do the complexities of managing assets, operations, and risk. The SMLLC structure offers useful flexibility, but it also raises important legal and compliance considerations that nonprofit leaders should understand before moving forward.
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Why Nonprofits Use SMLLCs
There are a number of reasons a nonprofit might form an SMLLC. Sometimes it’s about limiting liability — placing a potentially risky operation, like a retail shop or real estate venture, in a separate legal entity can help shield the parent nonprofit. In other cases, an SMLLC provides a useful structure for managing earned revenue activities, especially those that generate unrelated business income as noted previously.
The SMLLC can also offer practical advantages. It may make it easier to enter into partnerships or contracts, particularly in contexts where a more businesslike approach is helpful. And it gives nonprofits flexibility to pursue revenue-generating initiatives without directly involving the parent (nonprofit) organization in day-to-day operations.
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Understanding the Legal Structure
Under Michigan law, an LLC is a separate legal entity, even when it has only one member. That means the nonprofit must take steps to preserve the LLC’s independent status. It needs to file Articles of Organization with the State of Michigan, maintain a separate bank account, and keep clear records of the LLC’s activity.
It’s also important to create an Operating Agreement for the LLC. Even though the nonprofit is the sole member, the agreement should spell out how the LLC will be managed, who has decision-making authority, and how it will report back to the nonprofit’s leadership. Failing to observe these formalities can increase the risk that courts will disregard the LLC’s separate identity — undermining the protection it’s meant to provide.
—————
Governance and Oversight
Even when the nonprofit retains full ownership and control, it’s wise to approach the LLC as a truly separate arm of the organization. That includes appointing individuals—often board members or staff—to serve as managers of the LLC, and making sure important decisions are documented appropriately.
While the law doesn’t require formal board meetings or detailed minutes, maintaining clear records of decisions helps reinforce the LLC’s separate status. It also promotes accountability, especially if the LLC is handling assets or engaging in activities that are financially or legally significant.
—————
Tax and Compliance Considerations
From a federal tax perspective, a single-member LLC that is wholly owned by a 501(c)(3) is typically treated as a “disregarded entity” (pursuant to Treas. Reg. § 301.7701-2). That means its income, assets, and liabilities are reported directly on the nonprofit’s Form 990, and the LLC itself does not file separately with the IRS (unless the SMLLC submits Form 8832 electing treatment as a C-corporation).
However, that doesn’t eliminate the need for careful tax planning. If the LLC engages in activities unrelated to the nonprofit’s charitable purpose, those earnings may trigger Unrelated Business Income Tax (UBIT). The LLC may also need to register for state taxes, obtain licenses, and comply with Michigan employment laws if it has staff or pays contractors.
—————
Mission Alignment and Exempt Status
One of the biggest risks of forming an LLC is mission drift. If the LLC’s activities don’t align with the nonprofit’s charitable purpose, the parent organization’s tax-exempt status could be at risk. It’s essential to ensure that the LLC furthers—or at least does not conflict with—the nonprofit’s mission.
That means not only choosing the right activities, but also periodically reviewing the LLC’s operations to ensure compliance. Establishing internal reporting procedures and/or board oversight of the LLC can help ensure accountability and prevent unintended consequences.
Effective use of Single-member LLCs requires a comprehensive legal review. While they can be a powerful strategy for nonprofits - providing flexibility, protecting assets, and supporting mission-driven entrepreneurship - they’re not a one-size-fits-all solution and require more than a quick filing to work effectively.
—————
Zana Tomich is a co-founding partner of Detroit-based Dalton & Tomich PLC, where she serves privately held businesses and nonprofits, often in a general counsel capacity.
Recent work involves nonprofits that have formed SMLLCs to operate a daycare, a thrift store, or a podcast, and to house other “for profit” type activities. The SMLLC allows nonprofit corporations to keep income-producing ventures such as these separate to insulate themselves from both legal liability and from jeopardizing their tax-exempt status.
As nonprofits grow, so do the complexities of managing assets, operations, and risk. The SMLLC structure offers useful flexibility, but it also raises important legal and compliance considerations that nonprofit leaders should understand before moving forward.
—————
Why Nonprofits Use SMLLCs
There are a number of reasons a nonprofit might form an SMLLC. Sometimes it’s about limiting liability — placing a potentially risky operation, like a retail shop or real estate venture, in a separate legal entity can help shield the parent nonprofit. In other cases, an SMLLC provides a useful structure for managing earned revenue activities, especially those that generate unrelated business income as noted previously.
The SMLLC can also offer practical advantages. It may make it easier to enter into partnerships or contracts, particularly in contexts where a more businesslike approach is helpful. And it gives nonprofits flexibility to pursue revenue-generating initiatives without directly involving the parent (nonprofit) organization in day-to-day operations.
—————
Understanding the Legal Structure
Under Michigan law, an LLC is a separate legal entity, even when it has only one member. That means the nonprofit must take steps to preserve the LLC’s independent status. It needs to file Articles of Organization with the State of Michigan, maintain a separate bank account, and keep clear records of the LLC’s activity.
It’s also important to create an Operating Agreement for the LLC. Even though the nonprofit is the sole member, the agreement should spell out how the LLC will be managed, who has decision-making authority, and how it will report back to the nonprofit’s leadership. Failing to observe these formalities can increase the risk that courts will disregard the LLC’s separate identity — undermining the protection it’s meant to provide.
—————
Governance and Oversight
Even when the nonprofit retains full ownership and control, it’s wise to approach the LLC as a truly separate arm of the organization. That includes appointing individuals—often board members or staff—to serve as managers of the LLC, and making sure important decisions are documented appropriately.
While the law doesn’t require formal board meetings or detailed minutes, maintaining clear records of decisions helps reinforce the LLC’s separate status. It also promotes accountability, especially if the LLC is handling assets or engaging in activities that are financially or legally significant.
—————
Tax and Compliance Considerations
From a federal tax perspective, a single-member LLC that is wholly owned by a 501(c)(3) is typically treated as a “disregarded entity” (pursuant to Treas. Reg. § 301.7701-2). That means its income, assets, and liabilities are reported directly on the nonprofit’s Form 990, and the LLC itself does not file separately with the IRS (unless the SMLLC submits Form 8832 electing treatment as a C-corporation).
However, that doesn’t eliminate the need for careful tax planning. If the LLC engages in activities unrelated to the nonprofit’s charitable purpose, those earnings may trigger Unrelated Business Income Tax (UBIT). The LLC may also need to register for state taxes, obtain licenses, and comply with Michigan employment laws if it has staff or pays contractors.
—————
Mission Alignment and Exempt Status
One of the biggest risks of forming an LLC is mission drift. If the LLC’s activities don’t align with the nonprofit’s charitable purpose, the parent organization’s tax-exempt status could be at risk. It’s essential to ensure that the LLC furthers—or at least does not conflict with—the nonprofit’s mission.
That means not only choosing the right activities, but also periodically reviewing the LLC’s operations to ensure compliance. Establishing internal reporting procedures and/or board oversight of the LLC can help ensure accountability and prevent unintended consequences.
Effective use of Single-member LLCs requires a comprehensive legal review. While they can be a powerful strategy for nonprofits - providing flexibility, protecting assets, and supporting mission-driven entrepreneurship - they’re not a one-size-fits-all solution and require more than a quick filing to work effectively.
—————
Zana Tomich is a co-founding partner of Detroit-based Dalton & Tomich PLC, where she serves privately held businesses and nonprofits, often in a general counsel capacity.
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