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The L3C status: groups explore structure that limits liability for program-related investing.

An Internal Revenue Service (IRS) official's remarks about L3C corporations have drawn a strong rebuke from those behind the legislation, which is now recognized in five states.

During the recent national conference of the American Institute of Certified Public Accountants (AICPA), Ron Schultz, senior technical advisor with the IRS's Tax Exempt and Government Entities Division, warned against jumping on the LC3 bandwagon too early because of unresolved tax questions. "At the federal level, no one has really signed off" on whether a private foundation's investment in L3C could qualify as a program-related investment (PRI) under section 4944(c), said Schultz. "The IRS is in the process of studying the issue to determine the tax consequences of L3Cs," he said.

Bob Lang, president of the Mary Elizabeth and Gordon B. Mannweiler Foundation in Cross River, N.Y., essentially created the legislation that establishes Low-Profit Limited Liabilities companies. He had input from Marcus Owens, a former director of the IRS's Exempt Organizations Division and now an attorney with Caplin & Drysdale in Washington, D.C., and Arthur Wood, director of social financial services at Ashoka, in Arlington, Va.

An L3C corporation is a type of limited liability corporation (LLC) considered to be a hybrid, blending a nonprofit and for profit. The key is that it has a social benefit as its primary mission. The concept allows foundations to make PRIs.

In a letter to Schultz, Owens countered that the IRS has issued "considerable guidance addressing the federal tax consequences" for a private foundation or other 501(c)(3) that invests in an L3C.

The IRS has not "issued a ruling specifically analyzing whether a foundation's investment in an L3C qualifies as a PRI," Owens wrote. The IRS, he said, has "long approved foundation investments in for-profit entities--including, importantly, LLCs--as program-related investments, where the entity satisfied the PRI requirements." He cited at least five private letter rulings by the IRS, as far back as 1987 and as recently as 2005, labeling as not entirely accurate and possibly misleading, the assertion that the IRS has not yet considered the federal tax implications.

The L3C designation does not alter the legal framework for analyzing whether the foundation's investment in the entity would qualify as a PRI, Owens said. The designation also does not relieve a foundation "from its obligation to exercise appropriate due diligence to ensure that its investment furthers the carrying out of the foundation's exempt purpose," he wrote.

Foundations already use LLCs and corporations to accomplish charitable goals, according to Owens. Draft federal legislation creates a mandatory reporting requirement for for-profit entities that receive PRI where none currently exists, he said.

The Council on Foundations (CoF) is backing federal legislation that would complement L3C legislation already approved in six states. The bill would outline responsibilities, expectations and procedures for a potential IRS review process for PRIs and L3Cs. Legislation might relax, though not eliminate, the current need for Private Letter Rulings (PLR)--when private foundations are considering program-related investments in for-profit entities such as the L3C.

L3Cs can file in any of the five states that have passed legislation to establish the entity, and then can file as a foreign corporate entity in the state in which they are based, similar to Delaware corporations. L3C legislation has passed in Vermont, Michigan, North Dakota, Wyoming, Utah and the Crow Indian Nation in Montana. Legislation will take effect this fall in Maine and Jan. 1 in Illinois while several other states are considering similar measures. Lang said most L3Cs have filed in Vermont, with a growing number of economic development-focused projects also registering in Michigan.

"In truth, an L3C is a for-profit, so really the only aspect where any charitable official should have any question is if a foundation makes a program-related investment," said Lang, who also serves as president of L3C Advisors, an L3C Corporation he started to advise other L3Cs. He stressed that he is not paid by the small family foundation and his position is voluntary. "It's really up to the IRS to determine whether or not, when an investment is reported, if it's in compliance on program-related investments," Lang said.

There have been various inquiries from state charity officials, including a bevy of questions he's tried to address from the National Association of State Charity Officials (NASCO). "Technically, there are a lot of misnomers on that, including within the IRS," Lang said, pointing to the recent comments by Schultz. "It's a case where the right hand is not knowing what the left is doing," he said.

"These things tend to get a little inflated. People get a little panicky at the beginning," Lang said. "We want the best governance ourselves. It's become my life's work and I don't want anyone messing with that either," he said.

Rich Zwetsch and Caryn Capriccioso formed the Longmont, Colo.-based inter-Sector Partners, L3C, this past February, incorporating in Vermont and registering in Colorado, to advise entities looking into the L3C designation. "What we're really finding is lots of people putting their toe in the water," Capriccioso said. "Our real support is helping to determine whether it's right for them," she said. Most are entrepreneurs looking at socially responsible business models, interested in accessing foundation investments and capital.

Typically, Zwetsch said, the first step after an L3C is organized is to put a business plan together and pursue funding. Foundation PRI giving is still in its infancy as Zwetsch cited data from The Foundation Center indicating $131.5 million directed to nine recipients for 13 PRIs for the years 2008-2009. Federal legislation will go a long way toward clarifying current misunderstandings as well as the various misinterpretations by other aligned professionals who are just learning of this innovative new business structure, he said.

What nonprofits need to do is connect with people who can analyze the different alternatives, Zwetsch said.

"The rules of the game are changing, you can't do it the way you've always done it. That may involve getting other people on board to think through all the various different alternatives," he said.



The Montana Food Bank Network employs prisoner labor and uses donated equipment to run a food processing plant at the state prison in Deer Lodge, Mont. The facility was once part of the prison. After trying for several years to find funding for a new plant without much success, managers decided to go the Low-Profit Limited Liability Company (L3C) route.

The food bank network has a budget of about $2.5 million and approximately two dozen employees, providing food to almost 200 emergency food programs in Montana.

"A lot of times that's a reactive situation. We're trying to turn this into a proactive facility, producing products on a regular basis, not being reactive just to donations," said Peggy Grimes, executive director of the food bank network. "We're really food poor. We don't have a lot of access to Montana products or major manufacturers. There are very, very few in the state," she said.

An L3C is a type of limited liability corporation (LLC). It is considered a blend of nonprofit and for-profit. The key is social benefit as its primary mission. The concept allows foundations to make program-related investments (PRI). Nonprofits can reincorporate as an L3C or create a subsidiary L3C, which is the case with the Montana Food Bank Network.


Grimes learned of the L3C social enterprise almost two years ago through Bob Lang and Sen. Max Baucus (D-Mont.). Vermont was the first state to approve the designation, in April 2008. Six states and the Crow Indian Nation in Montana have followed suit. A federal proposal is also in the works.

"Low-profit is because most businesses, when set up, are focused on making a profit. We're not limited in how much profit can be made. The focus is not on profit, but supporting the mission, "that's the difference between L3C and LLC," she said.

When an L3C makes profit from its operating business, the funds can be funneled to the mission, or back to the organization, in the form of a grant from the business to the nonprofit. It's not considered unrelated business income and therefore not taxable for nonprofits.

The approximately 30,000-square-foot facility includes a 10,000-square-foot cannery where the organization processes donated food. The plan is to triple the size of it. Grimes anticipated the business plan will be completed at the end of the year. It set a path for an L3C corporation, as well as specifying the costs of construction, operations and other incidentals, along with a feasibility study. The food bank has a property in mind and at this point is determining what types of products would be best to process at the facility and what operational model will be best.

Once the food bank registers as an L3C, it will use the business plan to raise funds to construct buildings. Grimes expects ground breaking could come by late next year.

Grimes believes the L3C designation is the best business model for the project because the processing facility will have as its primary mission providing food for emergency food systems. "To me that's a huge benefit for our organization. It opens up our capability to be able to provide more food through the emergency food system," she said.

The new facility will also provide consistent training program for inmates at Montana State Prison and encourage Montana farmers to produce more high-value crops, which would provide more Montana food for state residents, Grimes said.


"We're really a commodity agriculture state," Grimes said. "Most of what's produced is shipped out and processed out of state. There is no processing in Montana right now. This project would bring back processing," she said. "People from all walks are really interested in seeing the project succeed, for one of those three reasons," Grimes said.

The L3C would relieve some of the nonprofit's strain of running the plant. There are two supervisors at the cannery who Work with 12 to 16 inmates. The corporation also could provide opportunities for economic development and jobs, Grimes said, adding more inmates in other areas like sales, warehousing and distribution. Part of the plan is to offer inmates, who are near to their release dates, the chance to stay within the L3C and continue to work and rebuild their lives, she said.

Grimes thinks the idea will catch on because nonprofits are always looking for a revenue stream generated through some business-related activity. The problem in most cases becomes a situation of mission creep or mission drift: An organization becomes so focused on the business that it loses focus on the mission it was organized to follow. "An L3C will allow us to continue to focus on our mission because an L3C is also focused on our mission," she said.

"A lot of nonprofits would relish that opportunity to generate revenue in a way that's beneficial for them in the long run and allows them to continue to focus on mission," Grimes said.
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Title Annotation:low-profit, limited liability corporations
Author:Hrywna, Mark
Publication:The Non-profit Times
Geographic Code:1USA
Date:Sep 1, 2009
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