Article by Kenya JH Smith
Imagine yourself representing a small, humble congregation of fewer than fifty people who have lived and worshiped in the same rural community for over 100 years. Sparked by their faith and determination to provide safe, decent, and affordable housing for members of the community who otherwise lack many of the necessities many Americans take for granted, the congregation agrees to sponsor a low-income housing tax credit (LIHTC) development. The deal is structured with the congregation's participation represented by an LLC formed as a wholly owned subsidiary of the congregation's longstanding nonprofit corporate entity. That LLC serves as one of the general partners but has no apparent decision-making authority. Those responsibilities are assigned to another entity serving as the managing general partner and to the limited partner representing the tax credit investor. However, the congregation contractually agrees to serve as guarantor on many of the development's obligations. As one might imagine, the congregation relies heavily on experts represented as having the requisite experience in LIHTC developments and sensitivity to the congregation's lack of financial sophistication or experience in this area to protect the congregation's interests. By faith, the congregation believes it will realize this part of its charitable mission.
All goes relatively well for the first ten-to-twelve years of the development. An eighty-four-unit senior living apartment complex is constructed, leased up, and operated with few operational difficulties. During year thirteen, a change in local tax assessors precipitates a change in the tax classification of the development from tax-exempt to being taxable as business. This change was not anticipated in the original underwriting of the development and triggers significant operating deficits. The congregation, as guarantor, is now called upon to use funds from its small accounts to stabilize a multimillion-dollar development that was represented as self-sustaining.
Driven to relieve the congregation of this burden, you scour the various deal points and research options provided in underlying law. Your research reveals an apparent argument that the congregation's LLC subsidiary complies fully with federal tax-exempt entity law and is properly formed under state law. However, in digging deeper, you are disappointed to discover the conflicted treatment of the nonprofit LLC in that context. The LLC is still interpreted as fundamentally a business entity and not entitled to an exemption from local property taxes. As it turns out, the “any lawful purpose” provision provided by law belies a long-standing restriction on which entities can qualify for state tax exemptions and other benefits that usually accompany nonprofit status.
Part II of this Article discusses the important role nonprofits play in American society. This Part also illuminates the additional burdens that nonprofits endure in navigating and interpreting the ambiguous and inconsistent myriad of state LLC laws, particularly their purpose provisions and their applicability in the nonprofit context. Part III analyzes three general categories of state nonprofit purpose provisions and how they impact the very viability of the nonprofit LLC. The first is labeled “Ambiguous Ambivalence.” It is by far the largest group of states and generally reflects a lack of depth in legislative consideration of how the LLC applies in the nonprofit context. The second category, labeled “Active Acceptance,” is represented by a small group of pioneering states (Kentucky, Minnesota, North Dakota, and Tennessee) who more fully embrace and thoughtfully regulate the nonprofit LLC. These states incorporate advisories regarding potential tax law implications. They also provide mandatory and default provisions designed to aid nonprofit LLCs in satisfying tax-exempt entity requirements. The third category is labeled “Amorphous Antagonism” and includes states that maintain apparent, if not open, hostility to the nonprofit LLC, expressed statutorily or through judicial interpretation. These descriptive categories collectively demonstrate the diversity in state law nonprofit LLC treatment. They also manifest the confusing ambiguity facing nonprofit LLC advocates at a time when clarity in nonprofit entity function and governance are of paramount importance. Part IV discusses the evolutionary trajectory of federal tax law nonprofit LLC treatment. This Part illustrates the nonprofit LLC's deliberate march toward broader acceptance under federal law and underscores the important and fundamental role that greater clarity and guidance in state LLC laws could provide in facilitating wider nonprofit LLC use.
About the Author
Kenya JH Smith. Kenya JH Smith is the Freddie Pitcher, Jr. Endowed Professor at Southern University Law Center and a former Deputy Mayor for the City of New Orleans. He received his B.A. in Political Science from Southern University at New Orleans and J.D. from the University of Wisconsin Law School. The endowed professorship is made available through the State of Louisiana Board of Regents Support Fund. This work was funded by a summer research stipend from Southern University Law Center, with thanks to Chancellor John K. Pierre. The author gratefully thanks all who have supported and contributed to this Article, including the administration, faculty, and staff of Southern University Law Center, as well as the members of the Southeast/Southwest People of Color Legal Scholarship Conference and the John Mercer Langston Black Male Law Faculty Writing Workshop. The author is particularly grateful to Professors Mitchell F. Crusto, Raymond T. Diamond, and Saru M. Matambanadzo for their comments, support, and mentoring.
Citation
95 Tul. L. Rev. 601 (2021)