Legal Options for Intentional Communities
Albert Bates, Allen Butcher, and Diana Leafe Christian explain the varying approaches to community property, governmental regulations for tax exemptions, and other issues that have implications in selecting the tax classifications best suited to your community’s needs.
Intentional communities generally arise from a specific idea or philosophy. Community members may be seeking an egalitarian, cooperative lifestyle; a self-reliant, back-to-the-land lifestyle; or a contemplative or spiritual lifestyle. They may want to edu cate or serve others, provide a nice place for a group of friends to live, or advance a combination of these goals. In any case, once an intentional community arises, attention begins to focus upon what kind of formal, legal organization best suits the gr oup.
Why Should an Intentional Community be Concerned with Legalities?
If it does not have a legal structure, problems can arise with regard to property rights for new members, compensation for departing members, personal liability, holding title to property and assets, or community agreements. Legal structures provide, if n ot a solution, at least a means to resolve problems fairly and equitably.
However, in the United States, the main imperative for organizing formally is taxes — a community must comply with the requirements of the federal Internal Revenue Service and state tax laws.
Since there are no legal forms created specifically for intentional communities — except perhaps 501(d) nonprofits, created for the Shakers and groups like them — communities often borrow from the various legal structures used in business organizations. Even though community members may not see their community as a “business operation,” forming a legal entity derived from the business world offers distinct advantages to an emerging community. First, any agreements the group makes as part of its legal st ructure, such as partnership agreements or corporate bylaws, will be compatible with state law and legally enforceable. Second, using a legal structure such as a partnership or corporation to form an intentional community offers advantages when buying lan d together. And third, the IRS and state tax officials will tax a community according to the legal form it has taken. Community Ownership and Legal Structures
The distinction between intentional communities and other forms of social organization is difficult to define from an inclusive legal perspective. It’s like trying to define a religion in the legal sense — it can’t be done in a truly descriptive way. Sti ll, unless you understand the different legal forms of organization, it may seem impossible to come up with a definition of what your community is or is not. But if you don’t do it, then the IRS will.
It is the kind of ownership a community has, as well as how its money is channeled, which will generally determine what kind of legal structure, or combination of structures, it should have. For example, in some intentional communities, each member-househ old owns its own lot, house, vehicles, tools, and equipment — little or nothing is owned in common. In other communities, the land, buildings, and all private property are owned in common, and shared.
In communal communities, not only does the community own property in common, but the members also have a common treasury — they contribute all or a portion of their income to the community, and the community in turn takes care of all or most of their nee ds. In still other communities, the members hold all land, buildings, and other assets in common, through a corporation, with individual members owning individual shares of these joint assets.
Many communities operate using several legal entities in an interactive fashion. In many “economically diverse” communities, the land and some buildings and equipment are held in common, while houses, cars, and bank accounts are held privately. The legal structure(s) that best satisfy the needs of one of these communities may be all wrong for another.
As far as possible, the object of choosing a legal structure is not to shape the community to fit the law, but to fashion legal forms that fit the community. Still, we have to admit, sometimes it’s easier just to shape the community.
Legal Options for Communities
Theoretically, any form of intentional community may be organized under any of the types of organized legal structures normally recognized by state governments. These include simple partnerships, Subchapter S corporations, Limited Liability Com-panies (re cognized in some states), limited partnerships, cooperative corporations, and nonprofit corporations. The latter include nonprofits for charitable, religious, or educational purposes; title-holding nonprofits, religious “common treasury” nonprofits, commu nity land trusts, condominium associations and other homeowners associations, and housing co-ops. Economically diverse communities often use more than one of these legal structures in an interactive fashion.
In this elementary form of legal association, two or more individual proprietors operate a common business. Each partner takes a share of the profits and pays the taxes on that amount, whether it is actually distributed or retained by the business.
The biggest advantage of the partnership form is its simplicity. In most states, the partners aren’t required to file any papers with the state; in fact, they can set up their partnership with just an oral agreement or a handshake. (If a community is form ed without any formal legal structures, the IRS and the courts would usually consider the community to be a partnership.)
A second advantage is that while the individual partners’ incomes are taxed, the partnership is not itself taxed, unlike corporations, which are subject to “double taxation.”
The biggest disadvantage of a partnership can occur if something in the community changes. This is because property rights and compensation of the partners are established by the original Partnership Agreement. If the Agreement is vague or does not antici pate every potential contingency, misunderstandings, disagreement, or other problems can arise if a partner or partners leave, new ones enter, or the Agreement dissolves. A second problem with partnerships is that each partner is personally liable for the partnership’s debts. For this reason, the business entrepreneurs of the nineteenth century created the corporation.
A corporation is an “artificial person,” set up to be a legal entity apart from its owners. Corporations are created by registering, and filing “articles of incorporation,” with officials of the state in which the business or intentional community is loca ted. A community corporation can make contracts, accumulate assets, do business, sue, and be sued in its own name. The owners, or shareholders, decide on the management of the corporation but are not liable for the debts or lawsuits of the corporation. Th is feature of “limited liability” is the principal advantage of creating a corporation.
The principal disadvantage is double taxation. Corporations are normally taxed on any profits before the profits are distributed to the shareholders as dividends. Then the shareholders may have to pay taxes a second time when they report their dividends a s income.
Subchapter S Corporations
This kind of corporation was created to help small businesses. The Subchapter S enables a small business (or community) to escape unfair situations, such as double taxation, while still obtaining the benefits of limited liability. To qualify for Subchapte r S, a corporation must have no more than 35 shareholders, none of whom is another corporation or trust (married couples are treated as one shareholder). A Subchapter S must operate a business that does not receive more than 20 percent of its income from passive sources such as rents and investments, and must obtain the consent of its shareholders to apply for the classification. Subchapter S corporations pass any profits through to their shareholders, who must report that income, whether distributed or n ot, on their tax forms. The corporation itself, like a partnership, is tax-exempt.
Limited Liability Companies
This legal structure, which is not a corporation, is recognized in some states but not others. Like a Subchapter S corporation, an LLC offers the advantages of a corporation’s limited liability. Similarly, it provides a way to tie decision-making rights d irectly to financial contribution — one “share,” one vote. An LLC has a partnership’s taxation status in that the LLC’s profits aren’t taxed directly; all profits and losses are passed through to the owners who pay income tax on their individual tax retu rns.
An LLC has advantages over an S corporation, including more flexible tax rules; more than 35 shareholders (called “members”) can participate; trusts, estates, corporations, partnerships, and non-American individuals and businesses can be members of the LL C; there are no restrictions on income sources; and it can have greater planning flexibility in reimbursing any founding members who leave.
LLCs have recently become more popular following a 1988 IRS ruling that an LLC in Wyoming would be taxed as a partnership, thereby allowing any profit and loss to be passed through to the members for their individual tax returns. Viewed conservatively, ho wever, we won’t know how LLCs will be taxed in other states until courts in each state that now recognize the LLC decide whether it’s a partnership or corporation.
The main disadvantage of an LLC is that, theoretically, LLC members could be personally liable for damages or debts incurred while conducting business in a state that didn’t recognize this business structure. States recognizing LLCs include Arizona, Color ado, Florida, Georgia, Idaho, Illinois, Iowa, Kansas, Louisiana, Maryland, Michigan, Minnesota, Mon-tana, Nevada, New Mexico, North Dakota, Okla-homa, South Dakota, Texas, Utah, Virginia, West Virginia, and Wyoming. States now considering LLCs include Haw aii, Indiana, Missouri, Nebraska, Pennsylvania, Rhode Island, South Carolina, and Tennessee.
This legal structure, which is also not a corporation, allows a business or intentional community to raise money, especially in times when loans are tight or interest rates high.
A limited partnership has “general partners” and “limited partners.” The general partners found the organization, assume all the responsibilities and take all the risks. They are personally liable for any lawsuits or debts incurred against the limited par tnership. A general partner can be a person, a partnership, or a corporation. There can be one or more general partners.
The limited partners are investors who contribute money (or land or other assets) and take the entrepreneurial risks. They have no say in the day-to-day management of the organization and are protected from liability for the partnership or community’s deb ts. If the organization fails, the most the limited partners could lose would be their original investment.
Limited partnerships come under state and federal securities regulations, and each state has different requirements to establish limited partnerships. They are usually more complex and costly to set up than other legal structures.
Unlike all legal options mentioned so far, which are expected to make money, nonprofits are primarily organized to serve some public benefit, and are not expected to make money. Hence, a nonprofit may obtain IRS and state approval for special tax exemptio n.
Most intentional communities have elected to organize as nonprofit corporations and to apply for tax-exempt status.
As with for-profit corporations, a nonprofit corporation is created by registering with the state — filing a list of corporate officers and articles of incorporation. After receiving state approval, the organization may apply for a federal tax exemption with the IRS.
Of course, some nonprofit intentional community corporations will not seek federal tax exemption because members view their communities as basic political units, to be operated separately from their spiritual or religious practice. On the other hand, ther e are communities with several corporations, some of which might be tax exempt while others are for profit, or nonprofit without tax exemption.
For those seeking to form tax-exempt corporations, there are several IRS tax exemptions to choose from. It is best to decide which category of tax exemption you are seeking before filing articles of incorporation, because the articles may have to conform to certain language that the IRS expects before it will grant a particular exemption.
Cooperative or Mutual Benefit Corporations
“Co-ops” are often used by consumer cooperatives (such as food-buying co-ops or credit unions), worker cooperatives, or producer cooperatives and are another legal option for communities with good state laws governing cooperative corporations. Co-ops are usually organized as nonprofit corporations; however, some states offer a special “cooperative corporation” category that is neither nonprofit or for profit.
In either case, to qualify as a co-op, the articles of incorporation must usually provide for open membership, democratic control (one member, one vote), no political campaigning or endorsing, and no profit motive — that is, a limited return on any inves ted capital. A co-op also provides limited liability to its members. In some states, members get nontransferable membership shares (instead of shares of stock) with an exemption from federal and state securities regulations. Any members who also serve as employees get tax-deductible fringe benefits.
501(c)(7) — “Social and Recreation Clubs”
Nonprofit mutual benefit corporations can use the IRS tax exemption 501(c)(7), which was created for private recreational or other nonprofitable organizations, where none of the net earnings goes to any member. This exemption can be used by a community wi th land which cannot legally be subdivided, yet whose members are required to put money into the community in order to live there, and who wish to recoup their equity if they leave. Members of a community organized this way “buy” a membership in the mutua l benefit corporation. They can later sell their membership (at a profit if they wish) to an incoming member.
The advantages are that, if organized properly, the community would not be subject to state and local subdivision requirements — because members wouldn’t own specific plots of land or specific houses. Rather, in a strictly legal sense, they would simply have use rights to any plots or dwellings (although the members’ internal arrangements could specify which plots or dwellings each would have preferred rights to use). In addition, members could pay for their membership with a down payment and installment s rather than in one lump sum. They would be afforded some liability for the actions of the mutual benefit corporation. They would also have the right to choose who joined the community, which could be an advantage over other land-owning legal entities su ch as P.U.D.s or other subdivisions, wherein the landowners would be subject to federal antidiscrimination regulations if they attempted to choose who bought into their community.
The disadvantages are that 501(c)(7) nonprofits can be quite complicated to set up and may require a securities lawyer, as they are regulated by the by the Securities and Exchange Commission. As such, a 501(c)(7) cannot advertise publicly for new members, who are legally “investors.” Rather, existing members or staff may only approach people they know personally to join them. A 501(c)(7) may have no more than 35 investor/members. No donations to such a community are tax-deductible.
There are no dividends or depreciation tax write-offs; members are taxed on any profit if and when they sell.
501(c)(3) — Educational, Charitable, or Religious Corporations
Nonprofit 501(c)(3) corporations must provide educational services to the public, offer charitable services to an indefinite class of people (rather than to specific individuals), combat negative social conditions, or provide a religious service to its me mbers and/or the public. (The IRS interprets “religious” very liberally; this can include self-described spiritual beliefs or practices.) 501(c)(3) nonprofits may receive tax-deductible donations from corporations or individuals, and grants from governmen t agencies or private foundations. They are eligible for lower bulk mailing rates, some government loans and benefits, and exemption from most forms of property tax. Religious orders that qualify under 501(c)(3) may also be exempt from Social Security, un employment, and withholding taxes in some cases.
In order to qualify for recognition as a 501(c)(3), an intentional community must meet two IRS tests. It must be organized, as well as operated, exclusively for one or more of the above tax-exempt purposes. To determine the organizational test, the IRS re views the nonprofit’s articles of incorporation and bylaws. To determine its operational test, the IRS conducts an audit of the nonprofit’s activities in its first years of operation.
Many communities have difficulty passing the operational test because of the requirement that no part of the net earnings may benefit any individual (except as compensation for labor or as a bona fide beneficiary of the charitable purpose). If the primary activity of the organization is to operate businesses for the mutual benefit of the members, it fails this operational test.
Even if the community passes the operational test by virtue of other, more charitable, public benefits — running an educational center, providing an ambulance service, or making toys for handicapped children, for instance — it can still be taxed on the profits it makes apart from its strictly charitable activities.
This catch, called unrelated business taxable income, has been a source of disaster and dissolution for some nonprofits because of the associated back taxes and penalties, which can assume massive proportions in just a few years of unreported earnings. Un related business taxes prevent tax-exempt nonprofits from unfairly competing with taxable entities, such as for-profit corporations. The IRS determines a nonprofit’s unrelated business trade income in two ways: the destination of the income and the source . If a community uses profits from bake sales to build a community fire station (presumably a one-time project related to the community’s purpose), the IRS may consider that income “related” and not tax it. If, however, the bake sales expand the general o perations of the community, or pay the electric bill, the IRS may consider that “unrelated” income, and tax it.
A Section 501(c)(3) nonprofit may not receive more than 20 percent of the corporate income from passive sources, such as rents or investments. If they are educational in purpose, they may not discriminate on the basis of race and must state that in their organizing documents. 501(c)(3) are not allowed to participate in politics — they can’t back a political campaign, attempt to influence legislation (other than on issues related to the 501(c)(3) category), or publish political “propaganda.” If they disba nd, they may not distribute any residual assets to their members; after payment of debts, all remaining assets must pass intact to a tax-exempt beneficiary — such as another 501(c)(3).
501(c)(2) — Title-Holding Corporations
This legal structure is a useful option for owning, controlling, and managing a nonprofit group’s property. The 501(c)(2) is designed to collect income from property — whether it is a land trust, a retail business, or a passive investment such as space r ental. All income is turned over to a nonprofit tax-exempt parent corporation, which is usually a 501(c)(3). The tax-exempt parent must exercise some control over the 501(c)(2) holding company, such as owning a majority of its voting stock or appointing i ts directors. The two corporations file a consolidated tax return. Unlike a 501(c)(3), a 501(c)(2) may not actively engage in “doing business,” except for certain excluded categories such as renting real estate or negotiating investments…and a 501(c)(2) can receive more than 20 percent of the corporate income from rentals or investments.
Many nonprofit communities, especially community land trusts (see below) find that having both 501(c)(3)s and 501(c)(2)s provide a needed forum to both run businesses and manage land and housing. The 501(c)(2) limits the community’s exposure to conflicts with the IRS over questions of income and possible personal “inurement,” or illegal benefits. 501(d) — Religious and Apostolic Associations
If a nonprofit community has a spiritual focus and a common treasury, it may apply for this tax-exempt status. (Again, the IRS interprets “religious” and “apostolic” very liberally; this can include self-described spiritual beliefs or practices, or secula r beliefs that are strongly, “religiously” held.)
In any case, the 501(d) is like a partnership or Subchapter S corporation, in that any net profits after expenses are divided among all members pro rata, to be reported on the member’s individual tax forms. Unlike the 501(c)(3), the 501(d) corporation can not confer tax deductions for donations.
501(d) nonprofits make no distinction between related and unrelated income. All income from any source is related. However, if a substantial percentage of community income is in wages or salaries from “outside” work, the 501(d) classification may be denie d. A 501(d) can engage in any kind of businesses it chooses, passive or active, religious or secular. The profits are taxed like those of a partnership or S corporation. But a 501(d) doesn’t have the restrictions of a partnership (it doesn’t have to refor m itself with each change of members), and it isn’t limited to 35 shareholders like the Subchapter S.
501(d) corporations have no restrictions on their political activity — they can lobby, support candidates, and publish political “propaganda.” They may or may not elect to have a formal vow of poverty. Upon dissolution, the assets of the 501(d) nonprofit may be divided among the members as far as federal law is concerned. However, state law generally requires that any assets remaining after payment of liabilities should be given to another nonprofit corporation.
The substantial advantages of the 501(d) may be outweighed in communities that would prefer to hold property privately. If the common ground between members is just that — the common ground — one of two other types of exemption may be more suitable.
Private Land Trusts
A private land trust is a legal mechanism to protect a piece of land from various kinds of undesirable future uses, like being sold for speculative gain; or to preserve land for various specific purposes — public use as a wilderness area, as rural farmla nd, or for low-cost housing. A land trust can be set up by an intentional community that has a specific purpose for the land, or simply to preserve it for future generations.
There are three parties to a land trust: the donor(s), who gives the land to the trust for a specific purpose or mission; the board of trustees, who administer the land and protect its mission; and the beneficiaries, who use or otherwise benefit from the land. People or institutions on the board of trustees are selected for their alignment with the goals and mission of the trust and their pledge of support. The trustees represent three separate interest groups: the beneficiaries, people in the wider commu nity, and the land itself. The beneficiaries can be people who visit a wilderness preserve or park, the farmers who farm the land, the owners or residents in low-cost housing on the property, or the members of an intentional community who live and work on the land. The donor, trustees, and beneficiaries can be the same people in a private land trust.
Community Land Trusts
A CLT is designed to establish a stronger and broader board of trustees than a private land trust. This is accomplished by creating a board with a majority of trustees that are not land users. Usually only one-third of the trustees can live on the land or benefit directly from it, while two-thirds must live elsewhere and receive no direct benefit from the land. This ensures that any donors or land-resident beneficiaries who are also trustees cannot change their minds about the purpose or mission of the tr ust, use the land for some other purpose, or sell it. The two-thirds of the board of trustees from the wider community serve to guarantee the mission of the trust since they are theoretically more objective, and will not be tempted by personal monetary ga in.
Private land trusts can be revocable by the original donors; community land trusts are usually not revocable.
Private land trusts and community land trusts are set up as nonprofit corporations, sometimes with a 501(c)(3) tax-exempt status. The trust holds actual title to the land, and grants the land residents long-term, renewable leases at reasonable fees.
The original owners of the land and assets cannot get their money out of a community land trust once they have made the donation. A CLT is an option for those who wish to ensure that the original purpose for their land and activities continues unchanged i nto future generations, and are not altered by subsequent requirements for quick cash, loss of commitment, or personality conflicts among the land residents.
Homeowners Associations, Condominium Associations
Some communities may choose to organize as a “Planned Community” — a real estate term, in which members individually own their own plots of ground and dwellings, and are each members of a nonprofit corporation — a “Homeowners Association.” The associati on, rather than the individual members, owns any community buildings and all the common areas, including land other than the individual plots.
Or a community may organize as a “Condomin-ium,” where the members each individually own the air space within their dwellings, and — as members of a nonprofit corporation, or “Condominium Association” — they own an undivided interest in the common eleme nts of the property. The common property includes the structural components of the individual dwellings (roof, walls, floors, foundation), as well as the common areas and community buildings.
Planned communities and condominiums aren’t legal structures; they are simply methods of purchasing land. In a planned community, the homeowners association owns everything but the individual units, and they must manage and maintain everything. In a condo minium, the condominium association owns nothing, but must manage and maintain everything. Both kinds of associations are often organized as nonprofits, under the Internal Revenue Code, Section 528.
Under Section 528, such an association is exempt from taxation in acquiring, constructing, managing, and maintaining any property used for mutual benefit. Such tax-exempt “association property” may even include property owned privately by members, such as a greenhouse, meeting house, or retreat. But to qualify, the private property must affect the overall appearance of the community, the owner must agree to maintain it to community standards, there must be an annual pro rata assessment of all members to m aintain it, and it must be used only by association members and not rented out.
The Association must also receive at least 60 percent of its gross income from membership dues, fees, or assessments. Also, at least 90 percent of its expenses must be for construction, management, maintenance, and care of association property.
Homeowners or condominium associations that want to use the 528 tax-exempt status don’t apply for this exemption; they simply incorporate under I.R.C. Section 528 and file an 1120-H tax return each year.
This is a very specific kind of cooperative corporation, also called a mutual benefit corporation. Housing cooperative nonprofits vary slightly from state to state. In general, however, members own shares in the housing cooperative, which gives them the r ight to live in a particular dwelling. Although nonprofits don’t usually allow shares of stock or stockholders, a housing cooperative does. The number of shares the members buy are based on the current market value of the dwelling in which they intend to live.
The members don’t own their individual houses or apartments; the housing cooperative does. The members have simply bought the shares, which gives them the right to occupy the dwelling of their choice. They pay a monthly fee — a prorated share of the hous ing cooperative’s mortgage payment and property taxes, combined with general maintenance costs and repairs. The monthly fee is based on the number of shares each of the members hold, which is equivalent to the dollar value assigned to their individual dwe llings.
In designing a new community, or transforming an existing one, it is imperative that mutually respectful relationships evolve among the participants. Often the process of choosing the legal organization is the first opportunity a community has to develop a convivial style of interpersonal relationships. Community members should be aware that creating formal bylaws and gaining corporate recognition is of a lower level of importance than the group’s actual process of self-definition — that is the crux of t he intentionality in intentional community. While debate over structure is occasionally the last act of a group, it is often the debate that is most fondly remembered in the years and generations to come.
Butcher, Allen, Community, Inc., P.O. Box 1666, Denver CO 80201.
Christian, Diana, “Legal Options for Commun-ities, A Five-Part Series,” Growing Community newsletter, 2Ð6, $5 ea. 1118 Round Butte Drive, Fort Collins CO 80524.
Alternatives Center, Co-op Housing, 1740 Walnut Street, Berkeley CA 94709, 510-540-5387.
Cohen, Lottie, and Lois Arkin, The Cooperative Housing Compendium (Davis, CA: Center for Cooper-atives, University of California).
Federation of Egalitarian Communities, Systems and Structures Package, Sandhill Farm, Rt 1, Box 155, Rutledge MO 63563.
Institute for Community Economics, The Com-munity Land Trust Legal Manual, 57 School Street, Springfield MA 01105.
For consultation and workshops on nonprofit tax exemption 501(c)(7)s and other financial/legal/real estate issues for forming new communities and retreat centers: Stephan Brown, 303 Hardister, Colverdale CA 95425, 707-894-9466.
About the Author
Allen Butcher first got involved with tax law in the early ’80s as a board member of the New Destiny Food Cooperative Federation and New Life Farm. He was a board member of the Foundation for Intentional Community during the period of expansion from regional to continental organizing. He served as Treasurer of the School of Living Community Land Trust. Allen lived at East Wind and Twin Oaks communities for 13 years, becoming a student of comparative economic systems in intentional communities. He has written a series of resource booklets for understanding and developing intentional community. While he was at Twin Oaks, Allen conceived the forerunner of this article for the last Directory. He now lives in Denver.
Albert Bates joined The Farm in Tennessee in 1972 after graduating from law school. He is a member of the Bar in Tennessee; General Counsel to Plenty-USA — The Farm’s international relief and development organization; Director of Plenty’s Natural Rights Center — a public interest law project; Editor/publisher of Natural Rights newsletter; and a former board member of the Communal Studies Association. As project manager of The Farm’s Ecovillage Training Center, Albert travels to Russia, where he works with an emerging ecovillage near St. Petersburg. Albert collaborated with Allen on the incorporation article in the last Directory.
Diana Leafe Christian, who lives in Fort Collins, Colorado, is Managing Editor of Communities magazine and former Editor/publisher of Growing Community newsletter (now a part of Communities magazine). She has extensive professional experience in editing and other news media work. Diana wrote a five-part series in Growing Community about legal options for intentional communities, some of which was adapted for this article.