Impact investing gets an IRS boost

Impact investing gets an IRS boost

Managers now can consider how a foundation's investments further its mission
Article posted in Investing, Values-Based on 20 October 2015| comments
audience: National Publication, Bruce DeBoskey, Philanthropic Strategist | last updated: 21 October 2015
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Summary

Bruce Deboskey looks further into a new IRS ruling that makes impact investing even more favorable.

By: Bruce DeBoskey, Philanthropic Strategist

Impact investing is one of the hottest topics in the philanthropic sector. It involves investments made with the intention of generating not just a financial return, but also a social or environmental impact — the double bottom line.

Until just recently, some foundation directors with an interest in impact investing felt restrained by their fiduciary duty to "exercise ordinary business care and prudence" in providing for the financial needs of the foundation, the breach of which could result in negative tax and other consequences.

In the September publication "Investments Made for Charitable Purposes," the IRS clarified this obligation and made thoughtful impact investing for foundations easier.

The new IRS notice states, among other things, that foundation managers now can consider whether an investment "is in furtherance of the private foundation's charitable purposes," even if the expected rate of return may be less than other possible investments.

Long-standing problem

Philanthropically committed capital is money that has been donated to a tax-favored vehicle like a foundation or donor-advised fund. In the U.S., nearly $1 trillion is committed to philanthropy in this way. The funds cannot be returned, the donor has already received a generous tax deduction, and the money is owned by the foundation or fund in order to achieve the donor's mission.

Typically, only 5 to 15 percent of those funds actually are used to make grants to nonprofit organizations to fund mission-related activities. The bulk of the money is invested to maximize the financial return, often without regard to the impact on society.

Imagine the power for good if donors also invested their philanthropically committed capital in a way that furthers the donor's charitable mission — investing for both financial gain and social impact!

Earlier this year, a survey of 64 large private foundations by the Center for Effective Philanthropy found that only 41 percent engaged in impact investing at all. Of those, the median percentage of endowments going toward this practice was a scant 2 percent.

The recent IRS announcement should help these numbers grow.

A few days after the notice was published (although in the planning stage for longer), the Kresge Foundation announced that it would put 10 percent of its $3.5 billion endowment into impact investing over the next five years.

"The language of philanthropy is shifting, from grant-making and social investing being seen as two disparate strands of investment, to a new model, where all types of social funding work in an integrated way toward the same end," Kresge president and CEO Rip Rapson said. "This solidifies the notion that we ... cannot solve complex social problems through traditional grant-making alone."

Using impact investing

The use of impact investments to unleash the full power of philanthropic capital is enticing. Foundation leaders should first seek expert legal and tax advice on the meaning of the new IRA guidance and how it fits with other IRS rules. Then, armed with that advice, they should consider the following steps:

• At the very least, make sure that philanthropic capital is not invested at odds with your mission. For example, is your health-related foundation invested in tobacco stocks? Or is your environmental foundation invested in coal extraction and consumption? Or is your foundation focused on opportunities for girls invested in clothing companies that employ women in foreign sweatshops at substandard wages? Ask the difficult question: "Where is our foundation's money spending the night?"

• Learn about program-related investments, which are a key tool for impact investors.

• Investigate additional types of investments that integrate with your grant-making, such as loans and equity investments in companies designing products and services that address social problems — like affordable housing, domestic microfinance, health solutions, clean tech and alternative energy.

Impact investing allows philanthropists to make more progress toward their charitable missions by using the engine of their philanthropically committed capital, rather than only the fumes.

The recent IRS notice is expected to give philanthropic leaders greater comfort to expand their investments — putting more of their money where their missions are.

Bruce DeBoskey is a Colorado-based philanthropic strategist working with The DeBoskey Group to help businesses, families and foundations design and implement thoughtful philanthropic strategies and actionable plans. He is the president of the Colorado Philanthropic Advisors Network, a teaching fellow with Boston College's Center for Corporate Citizenship and a frequent speaker at conferences on philanthropy. Visit deboskeygroup.com

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