A limited liability company is eligible to accept tax-exempt donations that are also tax deductible to the donor if the organization's operations qualify for one of the tax-exempt purposes that the government requires. An LLC is not tax-exempt until the Internal Revenue Service officially recognizes it as such. Obtaining this recognition requires a formal application and familiarity with the tax laws governing tax-exempt organizations.
Section 501(c) Sets the Framework
Internal Revenue Code Section 501(c) provides the framework that all organizations, including LLCs, must adhere to for purposes of obtaining tax-exempt status. The federal tax law always requires that the LLC be a nonprofit organization, meaning that its sole purpose is to further a charitable, religious, educational, humanitarian, scientific or literary cause.
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This is not to say that the LLC can't earn money; it only requires that it not distribute earnings to individuals or other businesses. The LLC must always reinvest the funds back into the organization to further its tax-exempt purpose.
Consider also: Sole Proprietor, LLC or S-Corporation: Tax Differences & Benefits
How to Apply
Limited liability companies must apply for the tax-exempt status with the IRS and wait until they receive approval before they can begin avoiding income tax liabilities on the donations they receive. This requires a representative of the LLC to prepare Form 1023.
The LLC must always reinvest the funds back into the organization to further its tax-exempt purpose.
The form is lengthy and requires full disclosure to a number of probing questions that allow the IRS to thoroughly assess whether the LLC satisfies all requirements of tax-exempt organizations. This includes information proving the organization's structure, a narrative of the operating activities of the LLC, compensation of its key officers and managers as well as a number of questions that relate to the essential requirements of IRC 501(c).
The IRS publishes a list of frequently asked questions regarding Form 1023 on its website.
Retroactive Tax Exemption
If an LLC is successful in obtaining tax-exempt status, the IRS will apply the exemption retroactively in some situations. Beginning with the month following the legal formation of the LLC, the IRS will allow the exemption for the entire duration of the LLC's existence if it receives Form 1023 no later than the end of the 27th month.
To illustrate, suppose you file the necessary formation documents with your state on Jan. 15, 2021; you start counting the 27-month period beginning on Feb. 1, 2021. Therefore, if you file Form 1023 for the LLC by April 30, 2023, the IRS will treat the organization as tax-exempt as of Jan. 15, 2021.
About Tax-Exempt Donations
The result of obtaining the tax-exempt status is that the LLC no longer must report the value of the donations it receives as taxable earnings. Moreover, it provides incentive for taxpayers to make donations to the LLC since the organization can now assure donors that their donations are fully tax deductible on a personal income tax return.
Once the LLC is tax-exempt, it will need to file annual informational returns with the IRS, but it will never pay income tax on donations.