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One of the attractive aspects of creating a private foundation as a vehicle for advancing an individual or family's charitable goals is the flexibility with which the trustees and directors of a foundation may invest the foundation's funds. Charitably minded individuals often are interested in "impact investing," or investing their charitable dollars in programs and projects that have investment potential, but more importantly, offer a potential benefit to society. Bill and Melinda Gates, through the Bill and Melinda Gates Foundation, are two famous examples of philanthropists who use a private foundation to make impact investments. Under the tax laws governing private foundations, the managers of a foundation are permitted to make "program-related investments" (PRIs) to advance their charitable aims. On April 25, 2016, the Internal Revenue Service published final regulations providing several new examples of PRIs. This post briefly explains PRIs and their benefits, and then highlights some examples of PRIs from the existing and recently issued regulations.

Under the Internal Revenue Code, there is an excise tax imposed on a private foundation if the foundation makes a "jeopardy investment" or "invests any amount in such a manner as to jeopardize the carrying out of any of its exempt purposes." Excluded from the definition of a "jeopardy investment" is a "PRI," an investment "the primary purpose of which is to accomplish one or more of the purposes described in section 170(c)(2)(B) [i.e., charitable, religious, educational, etc.] and no significant purpose of which is the production of income or the appreciation of property."

Investments that qualify as PRIs offer several significant benefits for a private foundation. A PRI will be a qualifying distribution for purposes of the foundation's 5% annual distribution requirement in the year the disbursement is made. Additionally, PRIs will not be treated as "business holdings" for purposes of the excess business holdings excise tax. A PRI is not includible in the foundation's distribution base for calculating the foundation's 5% distribution requirement for any year for which the PRI is outstanding. Finally, any income derived from a PRI in a trade or business will not result in unrelated business taxable income to the private foundation.

The regulations issued on April 25, 2016 add eight new examples of PRIs to the list of examples already contained in the regulations. In the preamble to the regulations, the IRS also highlighted a few important points about PRIs. Specifically, (1) an activity conducted in a foreign country can further an exempt purpose; (2) the exempt purposes served by a PRI may be broader than helping economically disadvantaged individuals and deteriorated urban areas; (3) the recipients of PRIs need not be charities if they are the instruments for furthering an exempt purpose; (4) as long as an exempt purpose is the primary purpose of the investment, a potentially high rate of return will not disqualify an investment as a PRI; (5) PRIs can be achieved through equity investments or loans to individuals, charities or for-profit organizations; and (6) a credit arrangement may qualify as a PRI.

Briefly, some examples of PRIs from the old and new regulations are as follows:

  1. A private foundation makes a loan charging a below market rate to a small business enterprise owned by members of an economically disadvantaged minority group in a deteriorated urban area who are unable to secure conventional sources of funds. Treas. Reg. §53.4944-3(b), Example 1.
  2. A private foundation that purchases stock in a small business enterprise owned by members of an economically disadvantaged minority group in a deteriorated urban area who are unable to secure loans without a greater equity investment to encourage lenders to support the business. Treas. Reg. §53.4944-3(b), Example 3.
  3. A private foundation invests in a business enterprise to develop a vaccine to prevent a disease that predominantly effects poor individuals in developing countries where the research and development of the vaccine is not commercially viable from ordinary investment sources. Treas. Reg. §53.4944-3(b), Example 11.
  4. A private foundation invests in a business enterprise in a developing country that delivers recyclable solid waste to recycling centers inaccessible to the majority of the population in the country. Treas. Reg. §53.4944-3(b), Example 12.
  5. A private foundation lends funds to a company that purchases coffee from poor farmers residing in a developing country to develop a training program for poor farmers to learn about advanced agricultural methods such as water management, crop cultivation, pest management and farm management. Treas. Reg. §53.4944-3(b), Example 16.

The IRS's new regulations on PRIs serve as a useful reminder that private foundations can be an effective vehicle through which philanthropically-inclined individuals and families may engage in societally beneficial impact investing.

Categories: Charitable Planning