Private foundations are becoming increasingly interested in providing seed money to for-profit enterprises whose activities further their charitable objectives. Examples might include a loan to a much-needed child care facility in a low-income neighborhood or an investment in a recycling center in a remote area of a developing country. These investments can serve as innovative alternatives to traditional grants to public charities.
Proposed regulations provide expanded examples of PRI purposes, recipients and financial structures.
Buoying the rising tide of investments in PRIs by young philanthropists, the IRS has recently proposed regulations providing extensive examples of approved PRI activities. See Prop. Reg. 53.4944-3(b), Examples 11-19. The examples range from orphan drug research and development to micro-lending in disaster areas to training poor farmers. Potential recipients can be any for-profit business as long as it furthers the foundation’s own tax-exempt purposes. Investment structures can also vary widely, from traditional loans and common stock purchases to loans with “equity kickers,” guarantees, or other participations.
PRIs are not considered “jeopardy investments.”
PRIs are exempt from private foundation excise taxes on “jeopardy investments” as long as the PRI’s primary purpose is to further the foundation’s tax-exempt purposes.
In addition, the significant purpose of the PRI must not be economic, i.e. production of income or appreciation of property. Generally, a below-market loan, or investment in a venture for which there is no commercial market, automatically meets this requirement. While the foundation does not have to offer terms that are commercially inferior, a competitive investment will trigger more scrutiny by the IRS.
PRIs can count toward a foundation’s minimum distribution requirement.
Every year private foundations must generally distribute at least 5% of their total assets as grants. A PRI equity investment (but not a loan) will count toward the foundation’s 5% annual distribution requirement. Furthermore, PRIs are not added to the foundation’s asset base for purposes of the 5% calculation.
Foundations must exercise “expenditure responsibility” over PRIs.
Foundations must exert all reasonable efforts and establish adequate procedures to: (1) ensure the investment is spent solely for the purpose it was made; (2) obtain full and complete reports from the recipients on actual expenditures; and (3) properly report to the IRS regarding such expenditures.
In addition, during the pre-investment stage it is suggested that the foundation obtain “a reasoned written legal opinion” regarding the tax-exempt treatment of the PRI, and a valuation if necessary. This can protect the foundation if the IRS later inquires whether the investment was “jeopardizing” to the foundation’s exempt purposes.
Finally, a PRI should be documented in a written agreement, signed by an authorized officer, director or trustee of the recipient organization, that tracks the above requirements of “expenditure responsibility.”
Conclusion
The breadth of social causes that tax-exempt PRIs can support through for-profit ventures, and the variety of ways to do it, are nicely elaborated in the proposed regulations. Many more foundations should consider joining the new generation of socially enterprising philanthropists, and broaden their palette of investments that can further their tax-exempt purposes.
