L3C
A Low-Profit LLC (L3C) is a hybrid business entity that combines the profit earning benefits of a traditional LLC and social interest of a non-profit. However, unlike conventional LLCs, L3Cs (low-profit limited liability companies) aren’t recognized in all 50 states. In addition, the primary goal of an L3C is for charitable or educational causes rather than earning money.
What you'll find in this article:
What is an L3C Company?
L3C vs LLC
How Do I Form an L3C?
Advantages of Forming an L3C
Disadvantages of Forming an L3C
L3Cs and Program-Related Investments
Frequently Asked Questions
What is an L3C Company?
An L3C (low-profit limited liability company) is a unique limited liability company comprised of non-profit and for-profit characteristics. For example, your L3C might seek to improve your local school system, feed hungry families, protect victims of abuse, or provide shelter for the homeless.
Your business must meet the following criteria to qualify as an L3C:
- It must considerably contribute to the objective of one or more charitable missions as defined by Section 170(c)(2)(b) of the Internal Revenue Code.
- Its primary business purpose must be to benefit society. So, although your L3C can generate an income, acquiring wealth and property can’t be your business’s first objective.
- It doesn’t benefit political or legislative goals.
L3Cs can be formed under low-profit LLC statutes in only a handful of states, including Illinois, Louisiana, Maine, Michigan, Rhode Island, Utah, Vermont, and Wyoming. While you can provide a more specific business purpose in most states, only the states listed above currently have statutes supporting the creation of low-profit LLCs.
L3C vs LLC
L3Cs and LLCs are structurally the same—both types of LLCs have members (aka owners), operating agreements, and management flexibility. However, the purpose of an L3C focuses more on bettering society versus earning a large profit.
Although L3Cs are philanthropic by nature, they still earn a profit—which means you’ll need to pay income taxes. When you form an LLC or L3C, the IRS classifies the business as a pass-through entity. So, business profits will be distributed to the owners who report their earnings on their personal income taxes. Both LLCs and L3Cs can also elect to be taxed as a C or S Corporation.
How Do I Form an L3C?
To form an L3C, you’ll need to file Articles of Organization (or your state’s equivalent) with your state’s business agency, typically the Secretary of State office. Required information will vary, but (at minimum) you’ll need to include the following information:
- Name of your L3C. Most states will require your business name to include “Low-Profit Limited Liability Company,” “Low-Profit LLC,” or “L3C.” However, a few exceptions, such as Illinois and Maine, specifically require the abbreviation “L3C.” In addition, the name of your L3C must be unique and distinguishable from other existing businesses within your state.
- Business address. You’ll need to include the physical address of where your L3C is located.
- Registered agent name and address. Your L3C must appoint a person or entity to accept legal and state documents on behalf of your business. Your registered agent can be you, someone within the business, or a third party such as a registered agent service.
- Member/manager information. Members are owners of the L3C. Members can choose to jointly run the business themselves. Or, they can appoint or hire managers to handle the business’s day-to-day functions.
- Signature and title of the organizer. You’ll also need to include the signature and name of the person filing your documents. This person is not required to be otherwise associated with your L3C.
Filing fees will range between $50 (Michigan) and $170 (Maine). You may file your Articles of Organization online, in person, or by mail. However, if you wish to submit a paper form in Vermont, you’ll need to request one from the Vermont Secretary of State, Business Services Division. All other states provide downloadable forms on their state websites.
Advantages of Forming an L3C
Forming an L3C is an excellent way to earn an income while focusing on social entrepreneurship. Simply put, creating an L3C allows you to own, control, and profit from your organization but still work towards a cause you care about and want to support. Additional benefits include:
- Liability protection. Because L3Cs have limited liability, they’ll protect your personal assets from potential legal action against your business, as well as business-related debt.
- Easy formation and maintenance. The filing process for an L3C is simple. In fact, it’s nearly identical to that of a traditional LLC. Plus, L3Cs aren’t required to hold annual meetings—unlike a standard corporation or benefit corporation.
- Ability to attract top investors. While some investors are solely concerned with profit, giving to charitable organizations can attract quality investors who are more personally invested in your cause.
Disadvantages of Forming an L3C
Although forming an L3C can be very appealing, there are a few things you’ll want to consider:
- Donations aren’t tax-deductible. L3Cs are technically considered for-profit businesses, so any donations made are not tax-deductible. This could potentially be a drawback for investors and other donors.
- L3Cs aren’t recognized in all 50 states. Currently, there are only eight states that have specific statutes regulating the formation of L3Cs. So, depending on where you live, starting an L3C may not be an option.
- Private foundations may be reluctant to invest. Unfortunately, private foundations can be hesitant to invest in L3Cs (or other for-profit charities) without pre-approval from the IRS, which can be time-consuming and expensive. More on this in the section below.
L3Cs and Program-Related Investments (PRIs)
The L3C business structure was designed to make it easier for private foundations to make Program-Related Investments (PRIs). But, what is a PRI and how are they connected to L3Cs? Let’s break this down.
Private Foundations and PRIs
Private foundations must allocate at least 5% of their assets for charitable causes each year to maintain tax-exempt status. Foundations can meet this requirement by making what’s called a Program-Related Investment (or PRI). PRIs can take the form of a loan, guaranty, or investment. So, unlike a grant or traditional donation, some form of return is usually expected. Private foundations like these types of investments because they can recoup their money while still helping support important causes.
When a private foundation makes a PRI to a for-profit business, the foundation could face hefty IRS fines if the money isn’t used appropriately. Foundations can request a Private Letter Ruling from the IRS to help ensure they’re in the clear—but obtaining a letter is time consuming and costly.
L3Cs and PRIs
According to the IRS, a PRI investment must further charitable causes. In addition, the organization itself can’t be politically motivated. Sound familiar? Yep—the exact requirements your business must meet to qualify as an L3C are identical to those the IRS has set for PRIs. Thus, eliminating the need for a Private Letter Ruling. Perfect solution, right? Well, not quite.
Currently, the IRS hasn’t officially approved L3Cs as a recipient of PRIs. Unfortunately, this could make private foundations hesitant to invest. For added insurance, foundations can still obtain a Private Letter Ruling, but (again) the process can be lengthy and expensive. Fees start at $275 and can quickly increase by thousands depending on the investor’s annual income.
Frequently Asked Questions
For an IRS-approved contribution, you can contribute cash, products, or time—but you must contribute without the expectation of getting something in return. This means that the IRS doesn’t consider selling products or services as a contribution. For example, suppose your L3C offers low-cost financial education for recently released inmates. In that case, that’s not considered a charitable contribution—at least not in the eyes of the IRS. However, if you donate 30% of your annual earnings back to local jails, that could be considered an IRS-approved contribution.
Yes. Each state will require your L3C to file an annual report each year with the state. Typically, your due date will be sometime during your anniversary month. So, if you formed an L3C on April 25, 2020, then your first report will be due during the month of April 2021. However, a few exceptions are Maine (due June 1 each year) and Rhode Island (due between September and November each year).
Filing fees will vary between states. However, you’ll likely pay between $20 (Utah) and $85 (Maine).
Maybe. Louisiana is currently the only L3C recognized state requiring new businesses to file an initial report attached to the Articles of Organization.
Yes. A non-profit corporation can own an L3C. Forming an L3C can help fund operations and pay workers. For example, let’s say you own a non-profit that teaches disadvantaged youth construction skills by assisting them to build homes. Under an L3C, you could sell those homes for a profit. Plus, if your L3C is owned by a non-profit, then the L3C itself could qualify as a tax-exempt entity.
L3Cs and benefit corporations are very similar in terms of business purpose—both seek to better the world. However, states typically impose stricter management and record-keeping requirements for corporations. For example, benefit corporations are often required to hold annual meetings and maintain meeting notes—whereas L3Cs are not.
Another significant difference is where L3Cs and benefit corporations can be formed. For example, you can create benefit corporations in 37 states (including District of Columbia), compared to only eight that allow L3Cs.
