The Low-Profit Limited Liability Company - dummies

By Jennifer Reuting

The low-profit limited liability company (L3C for short), the newest form of LLC, is a hybrid entity that sets out to bridge the gap between the for-profit and nonprofit business structures. L3Cs are a product of the social-consciousness movement and are still for-profit businesses, with the exception that profit motives take a backseat to the primary objective of public and social benefit.

In other words, the first goal of an L3C is to make the world a better place.

L3Cs can only be formed in a handful of states. However, they are quickly gaining in popularity and every year, more and more states are jumping on board. Here are the states in which you can form an L3C:

Illinois Michigan Utah
Kansas North Carolina Vermont
Louisiana North Dakota Wyoming
Maine Rhode Island

Here is the Vermont statute that defines the L3C and its requirements for compliance:

(27) “L3C” or “low-profit limited liability company” means a person organized under this chapter that is organized for a business purpose that satisfies and is at all times operated to satisfy each of the following requirements:

(A) The company:

(i) significantly furthers the accomplishment of one or more charitable or educational purposes within the meaning of Section 170(c)(2)(B) of the Internal Revenue Code of 1986, 26 U.S.C. Section 170(c)(2)(B); and

(ii) would not have been formed but for the company’s relationship to the accomplishment of charitable or educational purposes.

(B) No significant purpose of the company is the production of income or the appreciation of property; provided, however, that the fact that a person produces significant income or capital appreciation shall not, in the absence of other factors, be conclusive evidence of a significant purpose involving the production of income or the appreciation of property.

(C) No purpose of the company is to accomplish one or more political or legislative purposes within the meaning of Section 170(c)(2)(D) of the Internal Revenue Code of 1986, 26 U.S.C. Section 170(c)(2)(D).

The L3C is the first entity to be created with the IRS primarily in mind. The IRS offers tax relief for private foundation program-related investments, which promote socially conscious efforts, and the L3C was created to enable entrepreneurs to attract private foundation investment more easily.

Private foundations are typically penalized by the IRS if they make investments in certain for-profit entities. This can be frustrating for entrepreneurs looking for investment. With an L3C, entrepreneurs give up their tax benefits in exchange for the opportunity to have private foundations as investors who otherwise would not be able to invest.

Nonprofits are pretty restrictive in nature, but LLCs allow pass-through taxation, flexible membership and management, and freedom in how profits are distributed among the members. The L3C serves to take advantage of these benefits while allowing some of the tax advantages afforded to nonprofits.

However, unlike 501(c)(3) nonprofit organizations, donations and investments in L3Cs are not tax deductible. Likewise, L3Cs are not exempt from federal and state taxes. They are subject to pass-through taxation, similar to that of a partnership or sole proprietorship, and are not allowed to elect a special form of taxation like a regular LLC has the right to do.

On a brighter note, the IRS has yet to rule on whether the profit allocations of an L3C are subject to less taxation than the allocations from a regular LLC. We can only hope!

L3Cs are a powerful vehicle for various types of investors (from private foundations to individuals to government agencies) to take a risk on companies that offer a smaller chance of a fiscal return but possibly huge social benefits.

The capital structure of the L3C allows for tranching by offering multiple tiers of membership interests, with each tier offering a different balance of social rewards and fiscal returns. This system enables a socially conscious organization to obtain financing from foundations, which usually donate money only to nonprofit organizations, and more profit-minded individuals, who, while being socially conscious themselves, are still interested in getting a return on their investment.