2009 is an interesting year for the low-profit limited liability (L3C) concept because it presents the first test of an L3C’s ability to operate under current federal law and IRS regulations. One concern raised is the process by which private foundations will make program-related investments (PRIs) to this new legal entity.
A PRI is an investment tool that can offer private foundations more flexibility than a grant. It can be made to either a for-profit or nonprofit entity and can come in many forms such as a loan, loan guarantee, equity purchase, or other investment so long as it furthers the foundation’s charitable purposes. However, PRIs are not widely used. Community Wealth Ventures, Inc. reported that only 5 percent of all foundations have used PRIs. This may be due in part to the fact that PRIs are often viewed as legally complex and expensive to administer. The L3C was intended to maximize PRI utility and many question whether this is possible without a private letter ruling that specifically addresses the L3C.
A private letter ruling (PLR) is a written statement issued by the IRS that is requested by a taxpayer typically prior to a transaction. It advises the taxpayer of the tax treatment it can expect from the IRS based on the specific facts of the contemplated transaction, and is generally applicable only to the taxpayer that requested the PLR and cannot be relied upon by others. Importantly, as Robert Lang, CEO of the Mary Elizabeth & Gordon B. Mannweiler Foundation, points out in his article, “PRIs and Private Letter Rulings,” neither federal law nor IRS regulations require foundations to obtain a PLR before making a PRI. Private foundations can instead make a PRI according to the IRS guidelines of what constitutes an acceptable PRI.
Lang takes the position that a PLR is neither necessary nor efficient for making a PRI to an L3C. First, Lang explains that Marcus Owens of Caplin & Drysdale was retained to author the L3C legislation with the express instruction “to find a way to insure as best he knew how that the L3C legislation would make private letter rulings unnecessary” and that “[Owens] wrote the L3C legislation to dovetail with the federal IRS regulations relevant to [PRIs] by foundations.” He states that “[he] honestly believe[s] if an L3C is used and the IRS regulations are followed there will not be an issue. No one asks permission to drive the posted speed limit[;] why ask the IRS if you can follow their regulations?” Second, as Lang estimates, PLRs cost around $50,000 or more in legal fees plus an $8,700 fee to the IRS. These costs, in addition to waiting 12 to 18 months for the outcome, make PLRs “[h]ardly an efficient way to solve social problems.”
On the other side of this discussion, notwithstanding the L3C entity, is the fact that many private foundations in practice request PLRs for contemplated PRIs for reassurance of a favorable determination by the IRS prior to the actual investment. This is often motivated by the concern to avoid the costly penalties of jeopardizing investments (i.e., excise taxes under IRC Section 4944) if the investment is later determined to not be a qualifying PRI.
As Jane M. Searing highlights in her article, “Capital with a Conscience,” regardless of the PLR or non-PLR route, one thing is certain under current laws: whenever a foundation makes a PRI to a non–501(c)(3) organization, such as an L3C, expenditure responsibility is required. This requires the foundation to, among other things, engage in a pre-PRI inquiry with matters such as the identity, past history and experience, management, activities, and practices of the grantee organization, as well as complete additional requirements. See Treas. Reg. § 53.4945–5.
The PRI/PLR discussion remains in the early stages and neither the IRS nor Congress has signaled any movement on the issue despite encouragement from Lang, the Council on Foundations, and other L3C supporters. In July 2008, the Council of Foundations put their request for a blanket-PLR on L3Cs from the IRS on hold for reexamination in early 2009, and the Council of Michigan Foundations reported in February 2009 that Lang, Robert Collier, and Steve Gunderson were now pursuing the PLR on L3Cs; a PLR has yet to be issued. Additionally, since late 2008, Lang has been working on federal legislation that will federally approve the L3C designation, making it a recognized “brand” that allows PRIs without a PLR. However, until the IRS or Congress provides further guidance, the discussions will likely continue between Lang’s position and those, like Searing, who believe that “until the IRS changes the rules regarding expenditure responsibility reporting for program–related investments in non–public–charity organizations, significant private foundation investment in [L3Cs] is unlikely. If Congress makes this change, the use of L3C organizations will likely grow dramatically across the nation.”
For more background information on the low-profit limited liability company (L3C) concept, please view the previous posts, “L3C – Developments & Resources” and “L3C – Low-Profit Limited Liability Company.”
For more information on program-related investments (PRIs), please view a previous post, “CoF Advanced Legal Seminar – Program-Related Investments."
The Community Wealth Ventures, Inc. article, “The L3C: A New Tool for Social Enterprise” by Heather Peeler, is available here.
– Emily Chan