The hot topic in foundation circles today is the L3C, otherwise known as the low profit limited Liability Corporation. Experts tout it as the latest development in social enterprise. Several states are now legalizing L3Cs and the tax and philanthropic benefits that accompany them. You may have read the recent news concerning the Bill and Melinda Gates Foundation and its focus on “creative capitalism.” There has been increased emphasis on social enterprise organizations, and its supporters are currently pitching their use for federal approval.
L3Cs are part of a movement to expand the scope of charity, including foundation grants and individual donations beyond the 501(c) (3) public charity model. L3Cs open up private foundation money to the social enterprise sector; but only a very special kind of private foundation money known as PRIs (or Program Related Investments). PRI investments can come to a L3C in the form of a loan or equity an investment.
Now, you might ask; what does the word investment have to do with non-profits organizations like you involved in Social Enterprise? Think of it as high engagement grant making activity. In the same way a venture capital company invests in a for-profit enterprise in order to generate a return on investment. A foundation looks at its PRI investment money to further the “effectiveness” of its charitable dollars beyond making just an outright grant, which is the traditional means by which that you and I are most familiar with. One of the unique aspects of PRI money is that it comes back to the foundation grows and then is later “reinvested” for other PRI activities. Furthermore, the amount of PRI investment counts toward the mandatory 5% that foundations are required to give out in order to maintain its legal status as a private foundation.
Fundamentally, an L3C is a limited liability company (“LLC”), which is a type of for-profit legal entity that has existed throughout the World for over 1,000 years. LLCs are widely accepted and used, and are treated as partnerships for income tax purposes. Since, L3Cs are recognized as partnerships for income tax purposes, they file IRS Form 1065.
L3Cs are perfect for social entrepreneurs because they expand the scope of charitable thinking in a way that sort of convenes a charitable status to “for-profit” corporations as well as nonprofit charities. A L3C can also be considered to what is referred to as a “low profit company.” The chief goal of the L3C is to increase the flow of both private and philanthropic capital to ventures that further a charitable or educational purpose of some nature. The L3C hopes to accomplish this goal by wiping away some of the legal challenges associated with PRIs.
The L3C combines the unique features of an LLC with the “soul” of a nonprofit. L3Cs are profit-making corporations, but their owners don’t identify profit as their primary purpose. The mission of an L3C is a social benefit, doing socially productive and useful things, and only then earning a profit. By creating a vehicle that by law that complies with the requirements for a PRI, the L3C holds the potential of enhancing social enterprise sector activity and even helping 501 (C) (3)s that may choose to start a social purpose business.
Other Benefits of LLCs
Since an L3C fundamentally is an LLC, it is absent a special election to be treated as a corporation for tax purposes. The income from an L3C will be treated as a “pass-through” or “flow-through” entity for federal (and generally state) income tax purposes. It provides its members with liability protection against the actions and debts of the L3C. It also provides great flexibility with no limitations as to who may be a member and there are few restrictions imposed on its management.
What L3Cs Are Not
As important as what L3Cs are, is what they are not, a L3C is not an IRC Section 501(c) (3) organization and is not tax-exempt. It is not eligible to receive tax deductible charitable contributions under IRC Section 170. That said, PRIs are hybrids between grants and investments. Unlike grants, PRIs can be repaid and can produce a modest return on the investment. A classic example of a PRI is a no interest or low interest loan to economically disadvantaged businesses that are unable to obtain conventional financing.
So why do Foundations Make PRI investments?
Some private foundations feel PRIs-which are not outright grants but generally are required to be repaid-may be more effective in motivating an organization to accomplish its mission in an economically efficient manner. Private foundations may make PRIs without violating the special excise tax rules applicable to private foundations. Furthermore, PRIs have certain advantages over other investments under the private foundation excise tax rules.
The Council on Foundations has been actively promoting L3Cs, on Capitol Hill for the past two years. L3Cs are already in four states and two Indian reservations. Individuals can form L3Cs and attract various types of investors and, because of their charitable missions, tap into foundation loans and guarantees. At least they will be able to if Congress passes legislation giving blanket approval for such loans, or if the Internal Revenue Service (IRS) issues a ruling authorizing them.