It may seem like a very simple question: should my urban farm be a nonprofit corporation of a for-profit business? While urban agriculture has been traditionally rooted in nonprofit corporations, many people are beginning to look to for-profit entity options to house their urban agriculture operations. Many people think that if they plan to focus on growing and selling food in a low-income neighborhood, they should be a nonprofit corporation. Others think that if they want to make money growing and selling produce, they should be a for-profit business. The reality is that choosing between a for-profit and a nonprofit entity is a decision that should involve the careful weighing of numerous costs and benefits. This post will address important considerations that you should take into account when deciding whether to start a nonprofit or for-profit entity to house your urban agriculture enterprise. However, it’s important to note that this is only the basic information and which one is best for you will depend on your urban farm or garden.
First, let’s clarify what we’re talking about when we talk about an “entity.” An entity, at least as it will be used throughout this post, is essentially a legal construct that allows people to distinguish their work from their personal life, at least in a legal sense. In the context of urban farms and gardens, distinguishing the farm or garden from you as an individual is important for one big reason: it allows you to limit your personal liability for things that may go wrong. For example, say you want to start farm or garden on a group of properties down the street from your house. Since you want it to be a long-term project, you buy the group of properties from the landowner. If you haven’t formed an entity, you would have to buy the properties yourself and hold the title to the property in your name. Consequently, if anyone got hurt on the property the first thing they would do if they were interested in a lawsuit was look up who owned the property and in doing so would find your name. An entity allows you to limit your personal liability in relation to your farm or garden. If someone gets hurt on the property, they generally can sue the entity, whether nonprofit or for-profit, but not you as an individual. However, this is a common characteristic of all entities, whether nonprofit or for-profit. So what are the differences?
When we’re talking about nonprofit corporations, we’re talking about corporations that are organized and operated for public benefit rather than private gain. Nonprofit corporations are governed by the Michigan Nonprofit Corporation Act. Since they exist for public benefit, nonprofit corporations aren’t owned by any individual. Instead, nonprofit corporations are owned by no one and are managed by a group of at least 3 individuals commonly referred to as the Board of Directors as well as appointed officers, such as a President, Secretary, and Treasurer. In regards to its operations, nonprofit corporations are restricted by law as to what it can do with its assets. Most importantly, a nonprofit corporation cannot use its assets to enrich any director, officer, or member.
However, nonprofit corporations typically have to worry about more than the legal limitations placed upon them by Michigan law. Most nonprofit corporations also seek to become tax-exempt organizations pursuant to section 501(c)(3) of the Internal Revenue Code. While being a 501(c)(3) organization comes with key benefits, it also comes with key costs.
First the benefits. Tax-exempt organizations, as the name suggests, are exempt for federal, state, and local corporate income taxes. They also may be exempt from local property taxes so long as the nonprofit owns and uses the property for its tax-exempt purpose. Being a 501(c)(3) organization also comes with fundraising benefits. Most private foundations focus on providing grant funding to 501(c)(3) organizations and any gifts made the the nonprofit corporation are also tax deductible for donors.
But now, the costs. 501(c)(3) organizations must be organized exclusively for a charitable or educational purpose and must be operated primarily for a charitable or educational purpose. This restriction is the most important and the most frustrating. Just what is “charitable” and what is “educational?” Some activities are easy. Growing vegetables and giving it away to low-income people is clearly charitable. Teaching people how to garden is also clearly educational. Job training programs have also been clearly established as charitable activities. But what if a tax-exempt organization is selling food? Tying the sale of food to charity can often be difficult. Also, how much non-charitable and non-educational activity can a 501(c)(3) organization engage in? This line is never clear and it be difficult to even quantify an organization’s charitable activities and its non-charitable activities. But wait, we’re not done with the restrictions! In addition, 501(c)(3) organizations must be operated for public rather than private benefit, cannot participate or intervene in any political campaign on behalf of any candidate or public office, and a substantial part of its activities cannot include carrying on propaganda or otherwise attempting to influence legislation.
If it’s not clear by now, operating within the IRS regulations for 501(c)(3) organizations can be a headache as the organization has to constantly make the uncertain determination as to how the IRS will view the activity. If it operates afoul of IRS rules, it may incur tax liability or risk the organization’s tax-exempt status.
Rather than deal with the headaches described above, many urban farmers decide to form a for-profit business instead of a nonprofit corporation. The most prevalent entity choice for for-profit farmers is the limited liability company (LLC) given its flexible nature, easy management, and liability shield. All Michigan LLCs are governed by the Michigan Limited Liability Company Act. Unlike nonprofit corporations, LLCs are owned by private individuals and are generally operated for the private benefit of the owners. However, unlike the nonprofit corporation LLCs face very few restrictions as to the purposes for which they can be operated. If one person wants to start an LLC that has a strong charitable mission, they are free to do so. If another person wants to start an LLC with no charitable mission they are also free to do so. LLCs are also free of governance requirements. While a nonprofit corporation must be governed by a group of people known as Board of Directors, LLCs can be governed by any number of people. Further, LLCs enjoy a maximum amount of flexibility in deciding the rules that will govern the company as the owners can craft an operating agreement, which lays out the management structure for the company.
An LLC is free to operate for any legal purpose, can be owned by any number of individuals, and is free to craft management rules. So what are the negatives? The most notable is tax liability. An LLC is a pass-through entity for tax purposes. This means that the LLC itself will pay no corporate income taxes. Instead, all LLC income will be passed through to the individual owners. Individual owners will then generally have to pay a fairly hefty tax bill of 36% on all LLC income.
Back to the original question. You may be concerned about your farm or garden exposing you to personal liability and you’ve heard you can limit your personal liability by forming an LLC or a nonprofit corporation. You’ve read a lot about both entity options above. Which should you choose?
At the end of the day, only you can adequately answer the above question. First, you should think long and hard about what you want the core of your urban farm to be. Many urban farms have some charitable mission incorporated into their values, but will charity be your primary focus? Many urban farmers want to make a bit of money from selling produce, but do you want this to be a supplemental source of income or your primary livelihood? Once you’ve thought long and hard about your core purpose, it will be easier to go through the pros and cons and make an appropriate decision.
- Exempt from federal, state, and local corporate income taxes
- May be exempt from local property taxes
- Exempt from sales taxes
- Easier to obtain grants from private foundations
- Gifts to the nonprofit corporation are tax deductible
- Must be organized exclusively for a charitable or educational purpose
- Must be operated primarily for a charitable or educational purpose
- Must be operated for public rather than private benefit
- Cannot build personal wealth based on success as nonprofit assets cannot be used to enrich a director, officer, or member
- Must limit the nonprofit’s involvement in politics
- Higher degree of administrative complexity as it must be managed by a group of people
Limited Liability Company
- High amount of operational flexibility
- Low amount of administrative complexity as it can be managed by one person
- 36% tax rate for each individual owner on all of the LLC’s taxable income
At this point, you’ve thought long and hard about what the purpose of your urban farm will be. You’ve considered the pros and cons of the nonprofit corporation and the limited liability company. It’s decision time. However, there’s one last pause point. Forming a nonprofit corporation or an LLC is a decision that is hard to go back on meaning it can be difficult to transition a nonprofit organization to a for-profit organization and vice versa. So go over everything twice and think about it a bit more before you make your decision.