The Need for Hybrid Businesses

By Avdeev, Valeriya; Ekmekjian, Elizabeth C. | The CPA Journal, August 2012 | Go to article overview

The Need for Hybrid Businesses


Avdeev, Valeriya, Ekmekjian, Elizabeth C., The CPA Journal


Examining Low-profit Limited Liability Companies and Benefit Corporations

The economic recession has highlighted the need for socioeconomic reform. As businesses find themselves in the aftermath of the housing crisis - accompanied by an ongoing credit crunch with unprecedented unemployment rates, massive federal bailouts, plunging state revenues, and incomprehensible budget deficits - they are forced to reconsider and restructure their traditional methods of doing business. Similar to forprofit enterprises, nonprofit organizations are now searching for ways to generate a return. As the lines between the nonprofit and for-profit worlds blur, entrepreneurs worldwide continue to search for new legal structures mat better suit the present economic reality. Some are turning to hybrid entities, including the low-profit limited liability company (L3C), which was specifically designed to increase the number of program-related investments that private foundations can make to such socially centered businesses.

The discussion below focuses on limited liability companies (LLC) and the need for hybrid entities, specifically benefit corporations (B corporations) and L3Cs. Nonprofit organizations and program-related investment rules under the Internal Revenue Code (TRC) are also addressed. CPAs should remain abreast of L3C legislation and current developments in this area, as well as the intended use of L3Cs for program-related investments and other purposes.

An Overview of LLCs

Prior to August 1988, only two states had adopted LLC legislation: Wyoming in 1977 and Rorida in 1982. Before the IRS released Revenue Ruling 88-76 and its check-the-box regulations in 1997, an LLC - just like an L3C today - was viewed as an unfamiliar and confusing business structure.

Today, all 50 states have laws authorizing LLCs; in fact, LLCs are becoming the most popular business structure in the United States. An LLC is a very flexible and efficient business entity. Unlike an S corporation, an LLC has no limitation on the number and the type of owners; unlike a corporate entity, an LLC is not bound by complex state compliance laws; and unlike limited partners in a partnership, members of an LLC are not subject to potential vicarious liability for acts committed by co-owners in the ordinary course of business.

Tax-planning opportunities for individuals interested in creating an LLC are almost endless. LLCs can take the form of almost any business type. Specifically, an LLC with two or more members may be treated as a tax partnership; as a tax corporation, if it makes the necessary election; or as a taxexempt organization, with some limitations. In its Limited Liability Company Reference Guide Sheet, the IRS sets out the following 12 conditions that an LLC must meet in order to satisfy the tax-exempt status requirements under IRC section 501(c)(3):

* The organizational documents must include a specific statement limiting the LLC's activities to one or more tax-exempt purposes.

* The organizational language must specify that the LLC is operated exclusively to further the charitable purposes of its members.

* The organizational language must require that the LLC's members be IRC section 501(c)(3) organizations, governmental units, or wholly owned instrumentalities of a state or political subdivision thereof.

* The organizational language must prohibit any direct or indirect transfer of any membership interest in the LLC to a transferee other than an IRC section 501(c)(3) organization or governmental unit or instrumentality.

* The organizational language must state that the LLC, interests in the LLC (other than a membership interest), or its assets may only be availed of or transferred (directly or indirectly) to any nonmember, other than an IRC section 501(c)(3) organization or governmental unit or instrumentality, in exchange for fair market value.

* The organizational language must guarantee that, upon dissolution of the LLC, the assets devoted to the LLC's charitable purposes will continue to be devoted to such purposes. …

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