An L³C is not automatically, and does not seek to qualify as, a tax-exempt entity described in § 501(c)(3)—and it could not do so unless all the requirements for that status are met, as has been made clear by the IRS. Rather, it is anticipated that most, if not virtually all, L³C's will be structured to qualify as recipients of equity PRIs, with both taxable and tax-exempt owners. The L³Cs would, themselves, be taxable entities. In every version of the state L³C legislation that has been enacted, the definition of an L³C was carefully drafted to encompass the PRI requirements set out in the Treasury Regulations.

Presently, such taxable L³Cs are subject to the same oversight mechanisms as all other for-profit entities (including traditional LLCs and corporations) that receive PRIs from foundations. Before making an investment, the foundation may—but is not required to—secure a private letter ruling from the IRS, or an opinion of counsel, stating that the investment will qualify as a PRI. Once the PRI has been made, the foundation is required to exercise “expenditure responsibility” (due diligence) over the investment. This includes obtaining annual financial reports from the PRI recipient, which account for the foundation’s investment, and a statement that the PRI recipient complied with the terms of the investment. In addition, the foundation is required to report the PRI to the IRS on its annual information return (Form 990- PF).

Both the state L3C legislation and the proposed federal legislation are exclusively anti-abuse measures. Neither the state nor the federal legislation creates any legal benefit that does not already exist. To the contrary, both legislation’s create additional safeguards and enforcement mechanisms to ensure that PRIs accomplish charitable purposes.

• First, by enacting legislation that recognizes the L³C, states are creating a business form with an identifiable designation— i.e., “L³C.” The presence of the “L³C” designation signals to state regulators that the entity is organized and operated to accomplish charitable or educational purposes, and regulators may implement programs or mechanisms to monitor whether these requirements are being met. Indeed, it is virtually impossible for state regulators to identify taxable entities operating under a charitable purpose unless the organizations have been formed as L³Cs.
• Second, the proposed federal legislation creates a new mechanism for IRS oversight and approval of PRIs that consumes fewer IRS and foundation resources than the private letter ruling process by providing that the PRI recipient (rather than each foundation) requests IRS approval of the proposed PRI. The proposed approval process, like the current private letter ruling process, is voluntary. However, because the process is streamlined and because the PRI recipient can anticipate more funding if it has received IRS approval, the regime proposed in draft legislation should encourage voluntary requests for IRS review of these arrangements.
• In addition, the draft federal legislation creates a mandatory reporting requirement for entities that have been approved to receive PRIs where none currently exists under either federal or state law. Thus, the federal legislation should improve both the transparency of the PRI process and the accountability of organizations that receive charitable funding by establishing a clearly-defined screening mechanism within the IRS.