You Run a Youth Sports Organization. Should you set up a 501(c)(3) or an LLC?
This article originally appeared on SportsEngine. Republished here with permission.
Youth sports organizations are often run by people who are volunteers. Sometimes one volunteer within the group opens a bank account in the name of the sports organization, so fees can be deposited and expenses paid. Many times, a member of the group will suggest that the organization should formalize itself and set up a 501(c)(3) or an LLC to run the programs.
What do these terms mean and when would it benefit a youth sports organization to formally organize as a 501(c)(3) or an LLC?
First, let’s all get on the same page.
When a group of volunteers running a youth sports organization has not taken the step of creating a formal legal entity, they default to an unincorporated association. If the group is operating under the umbrella of an existing formal legal entity (when they are a program of an existing entity), they are not an unincorporated association, but rather part of an existing entity which is likely already a 501(c)(3) or an LLC).
A 501(c)(3) is a nonprofit corporation (formed pursuant to state law by filing Articles of Incorporation as a nonprofit) that has taken the additional step of applying to the IRS for federal tax exemption as a charitable organization and has been determined by the IRS to qualify as such. When a 501(c)(3) engages in an activity that creates liability, only the assets of the 501(c)(3) will be available to satisfy those liabilities. The members, officers, and directors of the 501(c)(3) are not individually liable for the debts or other liabilities (think personal injury, trademark infringement, etc…) of the 501(c)(3) so long as usual corporate formalities are followed.1 Also, a 501(c)(3) can receive tax-deductible contributions from the public and is exempt from the payment of state and federal income taxes for income related to its mission. 501(c)(3)s must have a board of directors who understand their fiduciary obligations as directors, are obligated to use all income for a charitable purpose and are expected to behave transparently.
A limited liability company is formed by filing simple articles of organization with the state. LLCs are formed to be a liability shield. When people form an LLC to undertake an activity like running a youth sports organization, only the assets of the LLC (its insurance and assets) will be available to satisfy any liabilities (the same examples as those listed above) created by the activities of the LLC. The assets of the individual members or leaders of the LLC will be protected from liabilities of the LLC, so long as usual corporate formalities are followed. An LLC is not exempt from federal or state income tax. It cannot receive tax-deductible contributions.
Question: Should a youth sports organization organize itself into a formal legal entity?
Answer: Yes. Unless the youth sports organization is operating under the umbrella of some other formal legal entity, it will almost always be worth the time and expense to organize the youth sports organization into some type of a formal legal entity to protect individuals from personal liability.
Why?: The members of an unincorporated association (those people who have agreed to run the organization together) are all liable for the actions of each other and for the activities they are running. For example, if a child is injured in the care of a program run by the unincorporated association, each of the members of the unincorporated association can be individually liable for damages resulting from the injury. Also, where, for example, one member of the unincorporated association signs a lease in the name of the organization, all of the other members of the unincorporated association become individually liable for the lease payments, should the group fail to pay.
Which entity type is best? Most youth sports organizations could choose to be formed either as an LLC or as a nonprofit/501(c)(3).
An LLC is a simple entity, formed with one state filing. The LLC is a flexible entity for tax purposes; it can elect to be taxed like a corporation or choose to have its income and expenses flow through to the people or entities that form it.
A 501(c)(3) is a far more sophisticated legal entity than an LLC. The 501(c)(3) is formed as a nonprofit corporation and then applies to the IRS for tax exemption. In exchange for the benefit of tax exemption, a 501(c)(3) is subject to complicated state and federal rules. Experienced legal or tax counsel should be sought prior to forming a 501(c)(3). A 501(c)(3) can be worth the significant upfront investment where one or more of the following are true:
The entity has a good chance at receiving gifts, grants, or contributions to fund its programs, in an amount that would significantly exceed the types of fee for service revenue a youth sports organization typically receives.
The entity will be a long-standing endeavor.
People are willing to invest the time and effort needed to understand the 501(c)(3) filing obligations and rules – someone will need to file a state corporate registration and an IRS filing (at least) each year.
People are willing to use the 501(c)(3) in a manner that benefits the public. This is critical when considering what type of entity to form. A 501(c)(3) cannot, for example, allow families to earmark donations or fundraising proceeds for the direct benefit of their children. Rather, in a 501(c)(3) all donations and fundraising proceeds are pooled, and the Board uses a non-discriminatory process to determine who needs scholarships to attend a camp.
Obtaining general liability insurance in a commercially reasonable amount is critical, whether the organization is a legal entity or not, and regardless of whether the entity is a 501(c)(3) or an LLC.
1. To be sure an entity provides a liability shield as intended, the directors and officers of the entity should follow typical corporate formalities like electing officers annually, keeping minutes of meetings, and making sure the entity has a reasonably sufficient amount of money in the bank to accomplish its purpose.