New IRS regulations encourage use of program-related investments

New IRS regulations encourage use of program-related investments

Article posted in Investing, IRS Notices on 16 June 2016| comments
audience: National Publication, Bruce DeBoskey, Philanthropic Strategist | last updated: 16 June 2016
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Summary

 Bruce DeBoskey, examines the recent IRS Notice that allows foundations more latitude in mission related investing.

By: Bruce DeBoskey, Philanthropic Strategist

Each year, more than 87,000 U.S. foundations make grants to help improve their communities, their nation and their world.

With more than $800 billion of foundation assets, these annual grants total more than $56 billion — doing a lot of good. Each year, however, nearly $750 billion remains in endowments — where it usually is invested for the single bottom line of financial gain.

Foundations traditionally have believed they must invest the bulk of their money to maximize financial return, with little regard to the impact of those investments on society or on a foundation’s unique mission.

In fall 2015, the IRS issued “Investments Made for Charitable Purposes” — a notice encouraging foundation managers to consider whether investments are “in furtherance of the private foundation’s charitable purposes,” even if the expected rate of return may be less than other possible investments. (For more details, see “Impact investing gets an IRS boost.”)

The Internal Revenue Service recently issued new regulations that encourage foundations to enhance the impact of their philanthropically committed capital by using program-related investments (permitted since 1969) when investing at least some of the significant funds that sit in endowments. These regulations give nine new examples of different types of PRIs.

Along with grants, PRIs can be part of an integrated strategy to achieve a foundation’s mission. A grant is a “social investment” that produces a positive social return to the community but a negative financial return to the donor. Once the funds are donated, they never come back to the foundation.

With a PRI, a foundation lends to or invests its endowment assets in a nonprofit or for-profit entity in a way that furthers its mission. At the same time, the investment has the potential of providing a positive financial return to the foundation.

To qualify as a PRI, three key criteria must be met:

  • The investment’s primary purpose must be to advance the foundation’s charitable objectives.
  •   Neither the production of income nor appreciation of property can be a significant purpose of the investment.
  • The funds cannot be used directly or indirectly to lobby for political purposes.

Examples of PRIs include:

  • Making a low-interest-rate loan to a nonprofit to pay off a building mortgage — saving the nonprofit significant interest over the life of the loan.
  • Making an investment in a for-profit company researching and developing an “orphan drug” to help cure a disease that primarily affects people in developing countries.
  • Investing in or lending money to a nonprofit or for-profit in a developing country that creates a recycling program to prevent pollution.
  • Lending money to or investing in small businesses that employ people after a natural disaster or in a low-income area where commercial funds are not readily available.

In announcing the new regulations, David Wilkinson, director of the White House Office of Social Innovation and Civic Participation, said: “We often think about philanthropy’s ability to make grants, convene and build partnerships but don’t always consider its investment capabilities.Traditionally, a foundation has viewed its financial resources as two distinct pots of capital: funds set aside for grants that further charitable purposes but are not repaid, and funds dedicated to investments, which provide a financial return and maintain the value of the endowment as an ongoing source for future philanthropic activity. Increasingly, foundations are realizing the benefits of tools for funding charitable projects that do not neatly fall in one category or the other.”

PRIs help nonprofits solve social and environmental problems by allowing them to use market-based tools to grow and recycle at least a portion of their sizable philanthropic assets for future use.

Foundation leaders who want to balance single-minded financial returns with broader-minded social impact can rest assured knowing the IRS now formally encourages the deployment of more of their philanthropic capital to achieve charitable goals.

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