Recently released guidance from the IRS has put program-related investments (PRIs) in the philanthropic spotlight. PRIs allow private foundations to invest their financial resources in causes consistent with their charitable missions. These investments often produce a greater charitable impact than dollars spent on traditional grant-making. But a historical lack of guidance in this area has made private foundations reluctant to engage in these innovative tools for giving. The new IRS guidance is encouraging social innovators to explore creative ways to maximize their charitable impact through the use of PRIs.
Program-related investments (PRIs) are gaining momentum in the philanthropic community as private foundations seek innovative and efficient ways to make an impact. PRIs are tools for giving that offer alternatives to conventional grant-making. Through the use of these vehicles, private foundations support their philanthropic missions by providing loans, issuing loan guarantees, and/or making equity investments in companies fulfilling a charitable mission.
While the advantages of PRIs are substantial, the uncertainty and complexity of the law, combined with significant penalties for noncompliance, have often deterred foundations from pursuing these investments. Recently, however, the IRS has issued much-anticipated guidance in Proposed Regulations (§53.4944-3) that clarify existing law on PRIs and illustrate a wider range of opportunities available to social innovators.
What Is a PRI?
To qualify as a PRI, an investment must meet three tests established by IRS regulations.
First, the primary goal of the investment must be to accomplish one or more of the charitable purposes described in the Internal Revenue Code, including, but not limited to, religious, educational, and scientific purposes.
Second, the production of income or appreciation of property must not be a significant purpose of the investment (Reg §53.4944-3(a)(1)). Actual receipt of a substantial return on investment, however, does not in itself indicate that production of income is a significant purpose of the investment (Department of the Treasury 2012). Rather, the relevant factor cited in the regulations is whether a private investor seeking profit would be likely to engage in the investment on the same terms as the private foundation.
Lastly, PRIs may not involve attempts to influence legislation or political campaigns (Reg §53.4944-3(a)(1)).
What Are the Benefits of PRIs?
Private foundations often receive a bigger bang for their charitable buck by employing PRIs than by making traditional grants. With grant-making, the expectation is that private foundation dollars will achieve a charitable purpose, but once expended, will never be recovered. An attractive element of PRIs is that funds invested in charitable programs will be repaid, possibly even with interest or some other form of financial gain, thereby enabling reinvestment of those same dollars in other charitable programs (Joseph and Kosaras 2008).
Although PRIs involve the expectation of repayment, dollars invested in PRIs contribute to a private foundation’s yearly minimum charitable distribution requirement (Reg §53.4942(a)-3(a)(2)(i)). Further, the amounts invested in a PRI are excluded from a foundation’s asset base for purposes of calculating the minimum distributable amount—the amount that the foundation must distribute annually to avoid IRS penalties (Reg §53.4942(a)-2(c)(3)(ii)(d)). Naturally, when these dollars are eventually repaid, they must be added back to the private foundation’s minimum distributable amount. This encourages foundations to redistribute the funds promptly for another charitable purpose.
Benefits are also extended to the organizations that utilize and sometimes leverage PRI funds received. Take, as a hypothetical example, a nonprofit enterprise seeking to build low-cost housing in an underprivileged part of Philadelphia.
The nonprofit has been unsuccessful in raising sufficient capital from donors, and it has been unable to borrow from lenders on terms that it considers economically feasible. To overcome this funding barrier, the nonprofit may seek out a private foundation with a similar mission that is willing to make a sizable loan bearing interest below the market for loans of comparable risk. Alternatively, the nonprofit may request that the private foundation guarantee a loan, thereby making the project more attractive to traditional investors and lenders. If one private foundation cannot fully fund the project, the nonprofit may request that the foundation become the lead sponsor by loaning a percentage of the funds needed with the expectation that this will entice other investors to participate (Prop Reg §53.4944-3).
Although the benefits of PRIs are numerous, and the results have been positive in practice, relatively few private foundations have pursued these investments (Feit 2011). A primary reason has been the lack of current guidance; existing Treasury Regulations meant to clarify the law were issued 40 years ago. These antiquated regulations list examples of PRIs focused primarily on fulfilling charitable goals benefiting underserved domestic areas and individuals. These examples have become stale and do not address today’s global environment, economic factors, or new opportunities available in making PRIs (American Bar Association 2010).
Making an investment that fails to meet the Internal Revenue Code definition of a PRI can cause significant or even fatal consequences to a foundation. Accordingly, private foundations have been inclined to seek legal opinions and/or obtain private letter rulings from the IRS—a costly and time-consuming endeavor—in an effort to substantiate an investment’s qualification as a PRI before making the investment (Feit 2011).
Increased Guidance from the IRS
At last, in April 2012, the IRS responded to escalating requests for current guidance by issuing Proposed Regulations. These welcome guidelines may be relied on currently by taxpayers. They clarify existing tax law on PRIs and open the door for private foundations to pursue more creative and complex PRIs.
The regulations provide a series of fresh examples illustrating investments that qualify as PRIs, thereby encouraging foundations to stretch their financial resources in innovative ways. New examples include scenarios in which foundations carry out charitable purposes in foreign countries. Additionally, the regulations illustrate a wider breadth of charitable purposes, including pursuing medical research, addressing environmental issues, supporting disaster relief, and promoting the arts. Further, professional advisors to private foundations can now rely on the new examples in the regulations to design optimal PRI structures (Prop Reg §53.4944-3).
Leaders in the philanthropic community are hopeful that this guidance will promote the use of PRIs, a traditionally under-used tool for giving. Though planning and professional advice are still necessary in creating and employing these charitable vehicles, some of the uncertainty has been put to rest, and the IRS tone is clearly encouraging. Many worthy social ventures in the Greater Philadelphia region can be achieved through PRIs. Now, it is up to funders, social entrepreneurs, and community leaders to utilize these investments to stretch financial resources and enhance their philanthropic impact.
IRS CIRCULAR 230 DISCLOSURE: To ensure compliance with requirements imposed by the IRS, we inform you that this document is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code, or (ii) promoting, marketing, or recommending to another party any transaction or matter that is contained in this document.
Antoinette (Nettie) Cristella began her career in public accounting at Drucker & Scaccetti, P.C. (D&S) in 2005 as an intern. In July 2010, Nettie became the youngest Managing Associate at D&S. She currently provides accounting, tax compliance, and business consulting services to a broad base of clients, including closely held businesses and their owners, partnerships, trusts, individuals, and tax-exempt entities, including private foundations and nonprofit organizations.
Nettie received her Bachelor of Science in Accountancy with a minor in Finance from Villanova University, where she graduated as the valedictorian of her class. She also earned a Master of Taxation degree from the Villanova Law School Graduate Tax Program in 2012.
American Bar Association, Section of Taxation. (2010). Comments on Proposed Additional Examples on Program-Related Investments (March 3, 2010). Available at http://www.americanbar.org/content/dam/aba/migrated/tax/pubpolicy/2010/
Department of the Treasury, Internal Revenue Service. (2012). Examples of Program-Related Investments. Federal Register 77(76).
Feit, B.N. (2011). What IRS Private Letter Rulings Reveal About Program-Related Investments. Taxation of Exempts (WG&L) 23(1).
Joseph, J.P. and A. Kosaras. (2008). New Strategies for Leveraging Foundation Assets. Taxation of Exempts (WG&L) 20(1).