The L3C, or low-profit limited liability company, is a new legal entity that could dramatically enhance funding sources for charitable and educational projects. The L3C could be useful to anyone who wants to further charitable or educational objectives. The L3C is a substantial development because it is extremely rare that the legal system creates new types of legal entities. Conducting business with a separate legal entity is a concept that dates to the Roman Empire. Over the past few centuries, however, legal entities have slowly adapted in response to the needs of the business community. The creation of the limited liability company in the 1970s and 1980s is one of the more recent examples.
The first L3C appeared in 2008 when Vermont amended its limited liability company act to include the L3C. Several other states have since created their own L3Cs, including Illinois, whose L3C provisions became effective on January 1, 2010. The trend indicates that most of the other states will eventually pass legislation creating the L3C. If organizing as an L3C is not an option in your state, you may still use the L3C for your organization by organizing in another state and obtaining authorization to do business in your home state.The L3C is unique because it combines characteristics of non-profit corporations and for-profit entities. The purpose of this structure is to facilitate cooperation between private foundations and for-profit businesses to provide charitable or educational services. The L3C differs fundamentally from a non-profit corporation because the L3C is in fact a for-profit business, meaning that it has equity owners who receive its profits.
However, profit is not the primary purpose of the L3C. Instead, the L3C must primarily further charitable or educational purposes. Funding provided by for-profit investors and private foundations enable the L3C to accomplish these purposes. For example, a charitable purpose could consist of providing low-interest loans to revitalize a blighted urban area.
The L3C could be an especially useful legal entity because it incorporates characteristics that the IRS requires of program-related investments (PRI). A PRI is an investment to accomplish charitable purposes that does not jeopardize the tax-exempt status of the private foundation providing the investment. Complex IRS regulations determine if an investment qualifies as a PRI. Most PRIs are investments in other non-profit organizations, but PRIs may also be investments in for-profit businesses. However, private foundations are often reluctant to invest in a for-profit business without clear proof that the investment qualifies as a PRI. Providing this proof can also be costprohibitive since it often involves technical legal analysis. The L3C will hopefully ameliorate this problem because it is thought that private foundations would more readily invest in L3Cs than for-profit businesses.
The structure of the L3C is designed to assure private foundations that an investment in the L3C likely qualifies as a PRI. The L3C structure provides this assurance by including in the L3C organizing documents characteristics the IRS requires of PRIs. For instance, the L3C articles of organization must set forth that the L3C is to significantly further charitable or educational purposes, no significant purpose of the L3C is the production of income or the appreciation of property, and no purpose of the L3C is to accomplish political or legislative purposes. Federal law may soon provide further certainty that investing in an L3C qualifies as a PRI. The Program-Related Investment Promotion Act of 2009 would create a process by which an L3C could receive a written determination
from the IRS that the L3C qualifies as a PRI. This is analogous to the determination letters the IRS issues recognizing the tax-exempt status of organizations under section 501(c)(3) of the Internal Revenue Code.
The L3C could increase the availability of for-profit funding for charitable or educational purposes by making otherwise unattractive investments more appealing to for-profit investors. For example, the L3C could be structured to allow for tranched investments. Regardless of the character of the for-profit investment, the LC3 will need to execute an expenditure responsibility agreement with the for-profit investor. These are complicated areas of the law and great care must be exercised in order to comply with IRS regulations. You should consult competent legal counsel prior to incorporating your L3C or making an investment in an L3C.
David L. Bea & Associates is carefully monitoring developments in this area of the law.
By Daniel J. Mays, David L. Bea & Associates
The foregoing article was provided for general information. Seek specific legal advice for your situation. If you have any questions, please do not hesitate to contact us.
© 2011 David L. Bea & Associates