The hot topic in foundation circles today is the L3C, also 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 come with them. You may have read the recent news about the Bill & Melinda Gates Foundation and its focus on “creative capitalism.” There has been a greater emphasis on social business organizations, and their supporters are currently promoting their use for federal approval.

L3Cs are part of a movement to broaden the reach of charity, including foundation grants and individual giving, beyond the 501(c)(3) public charity model. L3Cs open up money from private foundations to the social business sector; but only a very special type of money from private foundations known as PRI (or Program Related Investments). PRI investments can come to an L3C in the form of a loan or equity as an investment.

Now, you might ask; What does the word investment have to do with non-profit organizations like you involved in social enterprises? Think of it as a high-commitment grantmaking activity. In the same way, a venture capital firm invests in a for-profit company to generate a return on investment. A foundation analyzes your PRI investment money to promote the “effectiveness” of your charitable dollars beyond making a simple grant, which is the traditional medium you and I are most familiar with. One of the unique aspects of PRI money is that it returns to the foundation, grows, and is then “reinvested” for other PRI activities. In addition, the amount of the PRI investment counts towards the mandatory 5% that foundations must pay to maintain their legal status as a private foundation.

At its core, an L3C is a Limited Liability Company (“LLC”), which is a type of for-profit legal entity that has existed around 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 broaden the scope of charitable thinking in a way that gives charitable status to “for-profit” corporations as well as nonprofit charities. An L3C can also be considered to be what is known as a “low profit company”. The main objective of L3C is to increase the flow of private and philanthropic capital towards companies that promote a charitable or educational purpose of some nature. L3C hopes to achieve this goal by removing some of the legal challenges associated with PRIs.

The L3C combines the unique characteristics of an LLC with the “soul” of a non-profit organization. L3Cs are for-profit corporations, but their owners do not identify profit as their primary objective. The mission of an L3C is social benefit, to do socially productive and useful things, and only then make a profit. By creating a vehicle that statutorily qualifies for a PRI, the L3C has the potential to enhance the activity of the social entrepreneurship sector and even assist 501(C)(3) individuals who may choose to start a business for private purposes. social.

Other benefits of LLCs

Since an L3C is fundamentally an LLC, there is no special election to be treated as a corporation for tax purposes. Income from an L3C will be treated as a “pass-through” or “pass-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 can be a member and there are few restrictions placed on its management.

What L3Cs are not

As important as what L3Cs are, is what they are not, an L3C is not an IRC Section 501(c)(3) organization and is not tax-exempt. You are not eligible to receive tax-deductible charitable contributions under IRC Section 170. That being said, PRIs are hybrids between grants and investments. Unlike grants, PRIs can be repaid and produce a modest return on investment. A classic example of a PRI is a no-interest or low-interest loan for financially disadvantaged businesses that cannot obtain conventional financing.
So why do foundations make PRI investments?

Some private foundations feel that PRIs, which are not direct donations but generally must be repaid, may be more effective in motivating an organization to fulfill its mission in a cost-effective manner. Private foundations may conduct PRI without violating the special excise rules applicable to private foundations. In addition, PRIs have certain advantages over other investments under the private foundation excise tax rules.

The Foundations Council has been actively promoting L3Cs on Capitol Hill for the past two years. L3Cs are already in four states and two Indian reservations. People can form L3C and attract various types of investors and, due to their charitable missions, access loans and foundation guarantees. At least they will be able to do so if Congress passes legislation giving blanket approval to such loans, or if the Internal Revenue Service (IRS) issues a resolution authorizing them.