Differences Between a 501(c) and an L3C

By John Cromwell

The low-profit limited liability company, known as L3C, is a new organizational form that is now available for charitable organizations. The traditional method for organizing a charitable group is to file for 501(c) status with the Internal Revenue Service. Despite these organizational structures' shared focus on charitable purposes, they have some key differences regarding federal taxation, fundraising and distribution of organizational assets. Also, the group's location may influence the organizational options that are available. When considering which organizational type to pursue, consider consulting with an attorney.

Taxation

L3Cs are allowed to make profits, which are taxable by the IRS. On the other hand, 501(c) organizations generally are not structured to make a profit, which makes them exempt from taxation. These nonprofits include corporations organized by an act of Congress, charitable organizations, civic leagues, labor organizations, business leagues and fraternal societies. A very common organization under 501(c) is the 501(c)(3) entity. A 501(c)(3) is a foundation organized for a religious, charitable or educational purpose. A tax benefit specific to a 501(c)(3) organization is that any contribution it receives is tax deductible for the donor.

Fundraising

Nonprofit organizations have a wealth of fundraising options, from foundation and governmental grants to donations. As a for-profit organization, an L3C can raise capital by issuing debt or selling shares. However, its benevolent purpose may make it difficult to attract investment. To make up for this, the L3C was structured to obtain program related investments, or PRIs, from private foundations. Nonprofits are generally prevented from investing in for-profit businesses. With approval from the IRS, nonprofit foundations may invest in businesses through PRIs so long as the business in some way promotes the foundations’ charitable purpose. L3Cs are structured to expedite IRS approval for PRIs, and there is a movement to make it so any PRI made to an L3C is automatically approved.

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Distributing Organization Assets

Nonprofits are prohibited from distributing its assets to its owners or board members. The proceeds that the nonprofit generates from its activities must be used exclusively for its charitable purpose. In contrast, an L3C is permitted to distribute the proceeds from its activities to its owners.

Adoption of Organizational Form

Since section 501(c) is part of the U.S. Tax Code, any business in the country can apply for that status so long as it meets all requirements. On the other hand, only nine states allow L3Cs: Illinois, Louisiana, Maine, Michigan, North Carolina, Rhode Island, Utah, Vermont and Wyoming. Only organizations in these states can apply for L3C standing.

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Pros & Cons of the 501(c)(3)
 

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501(c)(3) Types

Federal taxes are a significant expense for many businesses, but not for exempt non-profits. Non-profit charities that are organized under Internal Revenue Code Section 501(c)(3) are generally tax-exempt, and their donors usually get tax breaks for supporting them. The IRS divides these charities into two categories: public charities and private foundations.

Can an LLC Be Non-Profit?

LLCs are formed under state law, so if LLC owners -- called members -- want to operate the LLC as a non-profit venture, they first have to determine whether this is permissible under the state law where the LLC is formed. As of January 2011, non-profit LLCs are not permitted in all states, so it's a good idea to retain an attorney to advise you on the legality and consequences of forming such an entity in your state.

Benefits for a 501(c)(4)

If you operate or have management responsibilities within a nonprofit organization, you may want to evaluate whether it satisfies the requirements of Internal Revenue Code 501(c)(4). In the event it does, there are a number of tax benefits of which the organization can take advantage that are only available to nonprofits that obtain tax-exempt status with the IRS.

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