Given the newspaper industry's financial difficulties and the social significance of news reporting and analysis, many journalism start ups are considering the L3C business form. Proponents argue that the L3C offers journalism ventures a sustainable business model with the potential to save newspapers. Yet, there are serious limitations to the L3C, including a capital structure largely dependent on an uncommon type of private foundation investment. For more information on whether forming an L3C is right for your project, see the Should You Form an L3C? section of this Guide.
L3C Business Form Basics
The L3C is a variation on the Limited Liability Company designed to take advantage of both non-profit and for-profit sources of capital. As the term "Low-Profit" suggests, an L3C typically engages in socially-beneficial activities which may not be lucrative enough to attract sufficient commercial investment. By using a tiered capital structure, the L3C can potentially attract a diverse group of creditors to finance its operations, including private foundations and socially-conscious for-profit entities.
In addition to the financing benefits, an L3C may offer a marketing advantage over the standard LLC in attracting socially-conscious investors and consumers. In contrast to a standard LLC, which can be organized for any lawful business purpose, an L3C must operate to significantly further a charitable goal as required by IRS Regs. Sec. 53.4944-3(a) . Still, any LLC can function exactly like an L3C if its articles of organization and operating agreement are drafted to track the provisions of Regs. Sec. 53.4944-3(a).
Tax Treatment of the L3C
Despite its socially-conscious mission, an L3C is not a tax-exempt organization under Section 501(c) of the Internal Revenue Code, and donations and investments in L3Cs are not tax deductible. Since the profits of an L3C "pass through" to its members and are taxed at individual rates, L3Cs operate like standard LLCs for federal tax purposes.
The L3C's primary advantage is its ability to attract private foundation Program-Related Investments (PRIs) though its formal compliance with the PRI requirements set out in Regs. Sec. 53.4944-3(a). PRIs are a means for private foundations to invest in for-profit entities without incurring certain penalty taxes. State laws authorizing L3Cs require their organizing documents to track the provisions of Regs. Sec. 53.4944-3(a).
As a cautionary note, however, the IRS has not ruled whether private foundation investments in L3Cs qualify as PRIs. State laws authorizing L3Cs do not bind the federal tax authorities regarding PRIs, which may limit the utility of the business form until the IRS makes its determination.
We also have a PDF version of our "Primer on Low-Profit Limited Liability Companies" that you can download here.
