Taxing Social Enterprise

By Mayer, Lloyd Hitoshi; Ganahl, Joseph R. | Stanford Law Review, February 2014 | Go to article overview

Taxing Social Enterprise


Mayer, Lloyd Hitoshi, Ganahl, Joseph R., Stanford Law Review


INTRODUCTION  I.   THE NEW HYBRID FOAMS   A. Low-Profit Limited Liability Companies (L3Cs)   B. Benefit Corporations   C. The Flexible Purpose Corporation   D. Other Hybrid Forms II.  TAXATION OF FOR-PROFIT AND NONPROFIT ENTITIES   A. Current Tax Treatment of For-Profits and Nonprofits   1. Taxing between the lines of for-profits and nonprofits   2. Rationales for the differing tax treatment      a. Subsidy theory      b. Tax-base theory   B. Current Tax Treatment of Hybrids   1. Benefit corporations and flexible purpose corporations   2. Low-profit limited liability companies   3. Conclusion III. SHOULD HYBRIDS RECEIVE SOME OR ALL OF THE TAX BENEFITS RECEIVED   BY CHARITIES?   A. Arguments in Favor of and Against Tax Benefits for Hybrids   1. The difficulty of defining public benefit   2. Risk shifting and its problems   3. State hybrid statutes and other forms of oversight are insufficient      to ensure public benefit   4. The risk of broken halos   B. Tax Benefits for Hybrids as Hybrids   1. Modifying the deductibility of charitable contributions   2. Eliminating automatic UBIT for hybrid S corporations   3. Other possible modifications CONCLUSION 

INTRODUCTION

"Hybrid" legal forms have proliferated over the past half decade, seeking to combine the potential for profit with one or more public-benefitting goals. (1) These forms include the low-profit limited liability company (L3C), the benefit corporation, and most recently the flexible purpose corporation. The stated purpose of these entities is to marry the capital and innovation that results from the ability to generate a profit for investors with the public benefit goals that characterize most nonprofits. While academics have sharply criticized the emergence of these forms with respect to both their necessity and feasibility, (2) states continue to pass legislation permitting them and private parties have begun to take advantage of this legislation. To date, eight states currently allow the creation of L3Cs, nineteen states and the District of Columbia have authorized the creation of benefit corporations, and the most populous state, California, has authorized the creation of flexible purpose corporations. (3) The most current figures indicate that over 1000 of these new entities now exist. (4) Although this figure pales in comparison to the number of more traditional for profit and nonprofit legal entities, (5) these new forms are now an established part of the legal landscape for those seeking to combine doing good with doing well. (6) Such efforts are commonly referred to as "social enterprise" and those engaged in them as "social entrepreneurs," although neither of these terms has a fixed definition. (7)

There is no single, representative example of the type of business that chooses to use a hybrid legal form. When Delaware recently permitted the creation of benefit corporations, one of the first entities to switch to this status was Plum Organics, a fast-growing company committed to providing healthy snacks for children and wholly owned by Campbell Soup Company. (8) When California permitted the creation of benefit corporations one of the first businesses to switch to that status was Patagonia, a family-owned maker of outdoor clothing and gear that contributes at least one percent of its sales to grassroots environmental groups. (9) And one of the first L3Cs is Maine's Own Organic Milk (MOOMilk), which ten organic dairy farms formed to help promote local family farming, and which the farmers, outside investors, and two nonprofits, the Maine Farm Bureau and the Maine Organic Farmers and Gardeners Association, own. (10)

To date, supporters of these hybrid forms have focused primarily on encouraging states to permit the creation of these new entities, but there have already been calls for these forms to receive some or all of the tax benefits enjoyed by charities. (11) As was the case with the calls to create these hybrid forms in the first place, such calls for tax benefits have met much skepticism. …

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