Colorado Llcs as Nonprofit Organizations

• Publication year: 1998
• Pages: 57
• Citation: Vol. 27 No. 8 Pg. 57

27 Colo.Law. 57 Colorado Lawyer 1998.

1998, August, Pg. 57. Colorado LLCs as Nonprofit Organizations

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57

Vol. 27, No. 8, Pg. 57

The Colorado Lawyer
August 1998
Vol. 27, No. 8 [Page 57]

Specialty Law Columns
Advising Nonprofit Organizations
Colorado LLCs as Nonprofit Organizations
by Robert R. Keatinge, Arthur A. Hundhausen
C 1998 Robert R. Keatinge and Arthur A. Hundhausen

The recent changes in Colorado unincorporated business organization law have created new alternatives for nonprofit organizations. As discussed in other articles, a nonprofit organization may be a member or partner in an unincorporated organization.1 This article considers another alternative the organization of a nonprofit or tax-exempt organization as an unincorporated business organization

Not all nonprofit organizations qualify as tax-exempt organizations. The term "nonprofit" refers to an organization that is not established for the purpose of making a pecuniary profit. Although not defined in this manner in the Colorado statutes, there are three common types of nonprofit organizations: (1) organizations that are organized for public benefit, (2) organizations that are organized for the mutual benefit of their owners, although not for financial profit, and (3) religious organizations The term "tax exempt" is used to describe an organization that is exempt from federal income tax on its income. Contributions to some tax-exempt organizations (referred to in this article as "charitable organizations")2 are deductible as charitable contributions.

Nonprofit Entities in General

An organization that is organized for a purpose other than making a profit may organize as a nonprofit corporation3 or as an unincorporated nonprofit association.4 In order to qualify as tax exempt under Internal Revenue Code ("Code") § 501(a), the organization must qualify under federal tax rules applicable to the particular type of exempt organization. Historically, tax-exempt organizations have been organized as nonprofit corporations and trusts, although, as noted below, there does not appear to be a requirement to that effect.

As partnerships, general partnerships and limited partnerships (including limited liability partnerships and limited liability limited partnerships) must be organized for profit.5 Similarly, business corporations under the Colorado Business Corporation Act must be organized for profit.6 Thus, Colorado partnerships and business corporations are inherently inappropriate as nonprofit organizations.

On the other hand, neither a limited liability company ("LLC") organized under the Colorado Limited Liability Act7 nor a limited partnership association ("LPA") organized under the Colorado Limited Partnership Association Act8 need be organized for profit. This flexibility should allow an LLC or LPA to have a nonprofit purpose and, if appropriate, to operate in a manner consistent with the requirements for tax-exempt or charitable status without violating the statutes under which they are organized. While LPAs may be organized for nonprofit purposes, this article focuses on LLCs because LLCs are more widely recognized.

Qualifying as a nonprofit organization is a matter of selection of state law and, in the case of an LLC, the provisions of the agreement governing the organization. Nevertheless, qualification as a tax-exempt or charitable organization will depend on the nature of the tax exemption sought.

In order to qualify as a charitable organization under Code § 501(c)(3), an organization must be "a corporation, community chest, fund, or foundation."9 Thus, in order to qualify as a charitable organization, an LLC or LPA would have to meet that definition. The federal income tax regulations governing the classification of an unincorporated business organization such as an LLC or an LPA as a partnership or corporation for federal tax purposes (the "Check the Box regulations")10 expressly recognize that an unincorporated business organization may qualify as an exempt organization under Code § 501 (a), but state that an organization that claims exemption will be deemed to have elected to be treated as a corporation for tax purposes.11 Although a senior IRS official commented last year that the IRS had not yet considered an application by an LLC for exempt status,12 according to IRS Publication 78, which lists organizations that have qualified as tax exempt, there are a few LLCs that have qualified as tax exempt.13

The Treasury Regulations impose both an operational test and an organizational test to determine whether an organization qualifies as a charitable organization.14 Under those tests, an organization must be organized and operated exclusively for one or more exempt purposes.15 Under the organizational test, the organization's articles of organization must limit the purposes of such organization to one or more exempt purposes; and not expressly empower the organization to engage, otherwise than as an insubstantial part of its activities, in activities that in themselves are not in furtherance of one or more exempt purposes.16

There appears to be nothing in the organizational test that would prohibit an LLC organized under the Colorado LLC Act from qualifying as exempt, provided that the articles of organization and operating agreement have sufficiently limiting language. The operational test simply requires that the organization be operated exclusively for exempt purposes, and, again assuming the articles of organization and operating agreement provide the appropriate purposes and limitations, an LLC, properly operated, should have no problem qualifying.

As noted above, not all nonprofit organizations are charitable or even tax exempt. Some organizations are established for the mutual benefit of their members. For example, such mutual benefit organizations as benevolent life insurance associations of a purely local character, mutual ditch or irrigation companies, mutual or cooperative telephone companies, and similar organizations may be tax exempt (although not charitable), provided that 85 percent or more of the income consists of amounts collected from members for the sole purpose of meeting losses and expenses.17

Normally, those organizations will be created under the nonprofit corporation law or under special statutes dealing with the particular mutual benefit organization.18 Particularly where a federal tax exemption is involved generally it will be more efficient to use...