On Sunday August 20th 2017, a group of us met on Roosevelt Island over Chinese food to discuss the future of this project. Those present were Jordan Mathews, Justin Mathews, Matt Trager, Josh Meyers, Matt Genkin, Deval Shah, and myself.
As a result of: that meeting, a later informal meeting that Josh arranged with Russell Dale and Sheila Hamanaka, consideration of Cam’s proposal, and the conversations I have had with several others, I now have a relatively fully-formed plan of action that I think will provide both sufficient structure for immediate progress in the short term and sufficient flexibility for future goal-setting, while soliciting minimal commitment from most participants.
An investigation of section 501 (see publication 557 chapter 3 and chapter 4) of the Internal Revenue Service (IRS) tax code shows that the federal government expects all not-for-profit organization to adhere to certain regularities.
Incorporation under 501(c)(3) requires that the principal activities benefit a public and not the members of the organization. 501(c)(3) incorporation shouldn’t be entirely ruled out, since we do expect our organization to do public good, but this public good must generally be evinced on the balance sheet and I don’t expect our organization would qualify for some time.
Incorporation under 501(d) as a communal/”religious” community engaged in small industry would seem to be a very promising alternative, except for the ruling that expressly forbids such organizations from deriving substantial support from members’ outside income, which is what I will propose below.
Incorporation under 501(c)(7) as a non-profit social club would seem to address these two issues. However, two new issues arise: Such clubs lose their status if they derive substantial income from a business activity, and likewise if their facilities are open to the public.
After observing such difficulties, the obvious question is: Why incorporate at all? The point is to form a legally-recognized entity capable of assuming liability from the individuals comprising the group, and participating in contracts with other entities in such a way that the documentary foundation we lay for the organization is largely legally enforceable. For example, so that the group can delegate the power of opening and maintaining a bank account to a member in their capacity as “treasurer” or something similar, in such a way that the delegation and all other group actions would be supported by, say, civil courts, were the legitimacy of these actions called into question in a dispute.
Remember that although formal “non-profit” status confers certain social privileges on an organization, from the point of view of the U.S. federal and state governments, the only reason for ascertaining this status is to qualify or disqualify an organization for tax exemption. On the other hand, in exchange for taxation, private companies are given a high (perhaps frighteningly high) degree of structural and operational freedom in comparison to their non-profit counterparts.
Consequently I recommend that we incorporate our group as a Limited Liability Company (LLC) and elect pass-through taxation. Such incorporation means submission of “articles of organization” and an “operating agreement” to the appropriate authority in a chosen state.
The following sketches one shape that our operating agreement could take, should we decide to incorporate as an LLC; please consider it only as a proposal, and not a dictum. I have not yet thoroughly researched the clauses that ordinarily appear in such operating agreements. The real thing will likely have to be much more detailed.
Unanimity minus 1. Important actions taken by the LLC shall generally be presumed to require unanimous consent of the members. Exceptions may obviously occur where the group has delegated a function to a member. Delegated actions may nevertheless be reversed by unanimous agreement of the complement of the delegate who took the action, i.e. by agreement of the other members. In general the group may sanction a member (e.g. eject a member) by unanimous agreement of the complement of this member. The requirement of unanimity may be relaxed in case a member makes him or herself unreasonably inaccessible for such decisions.
Delegation. Specific group functions, or collections of such functions (roles), may be delegated to individual members by group election from among those members who state competence to perform the role. Members generally cannot advocate for their own election to a role. The election methodology shall be: … . Such roles may be permanent or defined for a temporary purpose. These roles should include at least a treasurer and a director, whose functions are: … .
Joining the group. After inception, new group members may join with the unanimous consent of the existing members. It is anticipated that the members will use their vetoes only to prevent the introduction of new members which they believe to be an especially poor fit
Scale. The number of members is capped at 30. In case nearly 30 or more than 30 people express interest in joining the group, we shall provide material support and guidance to the prospective members towards the formation of their own group, modeled if desired on the exact same principles.
Monthly dues. The ownership interests in an LLC are allocated in what are called “units” or “member units” (rather than “shares”). Each member, for the duration of his or her membership, commits to a monthly payment in exchange for 1 unit. An elected treasurer is responsible for the maintenance of a bank account and the collection of these “member dues”. At the time of inception, each member submits to the treasurer in writing a statement of the percentage of their discretionary income that they would be willing to pay each month, e.g. 10%. (Optionally, the members may also submit an estimated statement of the amount of their monthly discretionary income). The smallest non-zero percentage submitted by the members becomes the collection rate.
Default. A member who stops paying monthly dues does not lose their existing units, but would fail to acquire new ones, thus gradually losing their ownership stake.
Leaving the group. In the event of a single member’s departure, the member may generally choose to “sell” their member units back to the LLC at a price more or less equivalent to the amount they bought them for.
Dissolution. In the event of several members’ departure, and these members elect to sell their member units, and the LLC cannot afford to buy them back, the LLC shall undergo complete dissolution. In general the assets held by the LLC would be sold and the proceeds distributed to the members on the basis of the member units. To be absolutely clear: If the company engages in no other activities besides its birth and death as per these procedures, it would function as a small scheme of redistribution of the members’ wealth. Prospective members should consider carefully if they are comfortable with this.
Taxation. An LLC may choose taxation on the individual pass-through basis (as an “S corporation”) or as a standard corporation (“C corporation”). We use the former. That is, the taxes levied on the profits of the LLC are in fact bourne by the members and stated on their individual tax returns, by means of the IRS form K-1 issued formally by the LLC to each member (“partner”). The distribution of the tax burden on the pass-through basis may be chosen to be different from the distribution of the member units. We choose the distribution proportional to the amounts of discretionary income, reported voluntarily to the treasurer each year expressly for this purpose and not subject to validation (i.e. “on the honor system”).
Two classes and activities. The group may decide to purchase property, whereupon some members may choose to live on the property as resident scholars. Those who do so would supported financially by the LLC and afforded considerable freedom in self-organizing their activities, in exchange for a measurable contribution of 20 hours per week to the maintenance and development of the physical community, including but not limited to: construction of study areas, workshops, or public gathering spaces, cooking, gardening, or agriculture, or small business activities like furniture manufacture or consulting. As long as the resident scholars maintain their measurable contribution, monthly accrual of their membership units persists at no cash cost. Note that this is consistent with the presumption of 0 discretionary monthly income in this case.
Disability. Residents who lose their ability to maintain their normal contribution should be offered alternative contribution activities to the extent that this is possible. Residents who lose their ability to maintain even the alternative contribution may, in exceptional circumstances and with the unanimous consent of the members, continue their membership and residency with the full support of the LLC.
Conversion. If the project succeeds, it may happen that either (1) the organization acquires sufficiently regular income from a small business activity to qualify the organization for 501(d) tax-exemption, or (2) the organization acquires sufficiently regular expenditures provably beneficial to the public to qualify the organization for 501(c)(3) tax-exemption. In these cases, the group may elect to liquidate a portion of the assets held by the LLC (in the proportions described in the “dissolution” paragraph), leaving the group sufficiently well-funded to continue its operations, and then re-incorporate as a non-profit organization.
If we manage to incorporate in Illinois, Kansas, Louisiana, Maine, Michigan, North Dakota, Rhode Island, Utah, Vermont, or Wyoming, we have the option of incorporation as a “Low-profit Limited Liability Company”, or L3C. This structure is designed for private companies whose principal purpose is social in nature and not profit-maximization. It is easier for L3C entities to obtain funding from non-profit foundations, because grants to L3C organizations can qualify as a “Program-Related Investment”, a form of expenditure sometimes required of such foundations by the Internal Revenue Service (IRS).
In the first year of operation, the group should focus on
The overall plan described above roughly represents one of two possible routes which was suggested in conversations during our August 20th meeting.
The alternative can perhaps be characterized as:
I will call this the “research center” model. It is much more plausible that such an organization could be formed as a 501(c)(3) non-profit company and derive substantial income from public foundation grants and other donations, with a relatively large number of its members working as full-time employees of the company.
Yet I offer the following critique:
I hope that someone will rebut this critique. The argument could begin with pragmatism; the research center model, being already in existence, is a more plausible place to start … etc.