By: Eli Korer
A little known entity available for organization in Illinois is the Low-profit Limited Liability Company (the “L3C”), which has been available for organization since early 2010. The L3C is designed to promote charitable organization by being a hybrid entity that has certain characteristics of “not-for-profit” organizations and “for-profit” enterprises.
Primarily, the L3C is a charitable organization. The L3C is a for-profit limited liability company which at all times furthers the accomplishment of one or more “charitable or educational purposes” within the meaning of the Internal Revenue Code, 26 U.S.C.A. § 170(c)(2)(B) (as described below), and which does not have as a significant purpose the production of income or the appreciation of property. While the significant purpose of the L3C may not be the production of income or the appreciation of property, the fact that a L3C produces significant income or capital appreciation is not, in itself conclusive evidence of a significant purpose involving the production of income or the appreciation of property. Additionally, the L3C entity may not be used to accomplish any political or legislative purposes.
The L3C must be organized to accomplish “religious, charitable, scientific, literary, or educational purposes, or to foster national or international amateur sports competition (but only if no part of its activities involve the provision of athletic facilities or equipment), or for the prevention of cruelty to children or animals.” 26 U.S.C.A. § 170(c)(2)(B) (West). Therefore, the L3C may be appropriate for people interested in organizing businesses relating to health care, animal or child care, community development, the arts, technology or environmental concerns.
While the L3C has attributes of a not-for-profit organization, L3Cs may not solicit charitable donations and persons or entities that make contributions, grants or gifts to L3Cs may not deduct them from their taxes because L3Cs are for-profit entities. L3Cs may accept private capital investment from members and “program-related investments” (“PRIs”) from private foundations. A “PRI” is an investment made by a private foundation to support charitable activities (26 U.S.C.A. § 4944 (West)); however, the investment may realize a return of capital and may come in the form of a loan, loan guarantee, line of credit, linked deposit or even equity investments. Private foundations are generally required to distribute 5% of their average net assets for charitable purposes on a yearly basis (26 U.S.C.A. § 4942 (West)). While these distributions are typically made in the form of traditional grants, they may also be made in the form of PRIs, which offers a potential return on a long-term investment. By having the capability to accept capital from both private investors and private foundations, L3Cs are in a unique fund-raising position, as compared to regular limited liability companies (“LLC”) or series limited liability companies.
While L3Cs carry out charitable missions, L3Cs are not exempt from the requirement to pay income tax. An L3C may elect to be treated as a corporation, partnership or disregarded entity for tax purposes. Additionally, like an LLC, the L3C may distribute all or part of its profits (after taxes) to its members.
There are many similarities between L3Cs and LLCs, which are specifically related to management and governing documents. Just like LLCs, L3Cs may be member-managed or manager managed and both L3Cs and LLCs are governed according to the terms of their operating agreements. There are, however, differences between L3Cs and LLCs with respect to registration requirements, the duties of managers, officers and directors, and reporting requirements. Under Illinois law, a L3C, and any chief operating officer, director, or manager of the L3C is a “trustee”, as defined in the Illinois Charitable Trust Act. The L3C and its managers, officers and directors, therefore, must meet certain requirements, which include, but are not limited to, registering with the Illinois Attorney General and filing certain annual financial reports. Any filing with the Illinois Attorney General (except for confidential registrations) will be made available to the public for inspect. Therefore, if the organizers of the to-be-organized entity value privacy, the L3C may not be appropriate. Additionally, the managers, officers and directors have heightened duties, including but not limited to the duty to avoid “self-dealing”, to avoid wasting charitable assets, to comply and cause the company to conform to the charitable purpose and the Charitable Trust Act.
Depending on the purpose of the entity, and the anticipated sources of investment capital, a L3C may be the appropriate entity for your business.
To discuss entity selection, L3Cs generally, or focused issues relating to L3Cs such as PRIs, tax treatment, or management and operation, please contact:
Eli Korer at:
firstname.lastname@example.org or 312-368-0100.