Recently, Illinois became one of the states to permit formation of low-profit limited liability companies (often called “L3Cs”), by adopting 805 ILCS 180/1-26, as added by P.A. 96-126 (the “Act”). The main advantages of L3Cs are their tax treatment and flexibility generally associated with the limited liability companies. Unlike traditional not-for-profit entities, L3Cs do not need to rely solely on grants or other charitable contributions.
An L3C is defined as an entity that satisfies the requirements of Section 1-26 of the Code and does not have as a “significant purpose the production of income or appreciation of property.” 805 ILCS 180/1-5. An L3C can be managed by one or more of members or by an outside party. An L3C can be managed by a governing board, committee, or officers.
L3Cs can provide unique opportunities for the investors. A properly structured L3C can operate as a for-profit entity to achieve various charitable or social goals. L3Cs permit the program-related investments of private foundations without jeopardizing the foundations’ tax exempt status under the Internal Revenue Code. Thus, L3Cs should encourage investments by broad range of private foundations and government agencies as they allow for-profit entities, not-for-profit organizations, and individuals to become members of the L3Cs. Both for-profit entities and not-for-profit organizations can invest in L3Cs and be their members.
Ironically, the IRS has yet to recognize L3Cs or provide a regulation for determining what investments in L3Cs qualify as program related. As the result, a private foundation cannot be certain that its investments in an L3C will qualify as program-related investment unless the foundation obtains a formal private letter ruling from the IRS approving the same. This process can be costly and time consuming. Alternatively, the private foundation may get an opinion of counsel, approving the treatment of investment as a program-related investment. This process may be worthwhile as the program-related investments would help the foundations to meet its annual five percent net asset distribution requirements.
Described below are a few examples of the objectives for which L3Cs may be appropriate:
- Investments in Economically Distressed Areas. To create jobs and encourage economic development in an economically distressed area, a private foundation may negotiate with the private investor a financing of a local business, such as a grocery store or a small manufacturing facility. Such business would employ local residents. A private investor may not be willing to undertake such a risky development from the beginning. However, once the newly formed business reaches certain economic sustainability, the private investor would buy-out the business from the foundation, thereby helping the foundation to achieve its goal.
- Program-Related Investments. An L3C may engage a private operator to acquire and rehabilitate a commercial or residential building in an economically distressed area, and rent it to the local businesses or residents at very low rates. While such project may not be economically feasible for a private investor, i.e. providing limited or negative return on investment, a foundation-funded L3C would create jobs and spur economic activity in the economically distressed area.
- Socially Responsible Investments. L3Cs can operate medical or elderly housing facilities for low income aging population. L3Cs allow both not-for-profit and for-profit entities to combine funds to make socially responsible investments.
Importantly, a limited liability company intending to operate as a low profit limited liability company must include the term “L3C” in lieu of “LLC” or “L.L.C.” in its title. An L3C company should also include the following three statements as part of its purpose in Article 5 of the Articles of Organization:
- The company intends to qualify as a low-profit limited liability company pursuant to Section 1-26 of the Limited Liability Company Act and shall at all times significantly further 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, or its successor, and would not have been formed but for the relationship to the accomplishment of such charitable or educational purposes.
- No significant purpose of the company is the production of income or the appreciation of property.
- 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.
The full text of the Act is available at the Illinois General Assembly site: http://ilga.gov/legislation/publicacts/fulltext.asp?Name=096-0126&GA=96.
Should you have any questions regarding the above-mentioned issues or other corporate formation matters, please contact us today.