IRS Guides Foundations in Making Investments

Investments must advance ‘charitable purpose’ to qualify as PRIs

Bill Gates, center, and his wife, Melinda. Their foundation has a fund for making loans to NGOs and companies. Bill Gates, center, and his wife, Melinda. Their foundation has a fund for making loans to NGOs and companies.

The Treasury Department is giving private foundations that use program-related investments in the form of loans or capital investments a helping hand in deciding whether their investments qualify for beneficial tax treatment.

U.S. private foundations have been allowed to make PRIs since 1972 in order to stimulate or advance their charitable aims.

In April, Treasury proposed regulations that would update examples of investments that qualify as PRIs and can receive special tax treatment. The new regulations would not modify existing ones, but expand investments that could qualify as PRIs.

Private foundations and their managers can incur excise taxes for making investments that jeopardize their exempt status. This tends to happen, the IRS says, when “foundation managers fail to exercise ordinary business care and prudence in providing for the long- and short-term financial needs of the foundation.”

PRIs are exempt from excise taxes so long as they are intended to advance a private foundation’s charitable aims. They may not be used to produce income or to influence legislation or support political campaigns.

Prominent private foundations, as well as many lower-profile ones, use PRIs. The Pearl M. and Julia J. Harmon Foundation, for example, makes low-interest loans of $1 million to $2 million every year to charities located mainly in Arkansas, Kansas, New Mexico, Oklahoma and Texas.

The Bill & Melinda Gates Foundation has a fund for making loans to NGOs, financial institutions or companies; investing in funds or purchasing of shares in companies; and doing bond backstops or credit guaranties. The New York Times reported in November that the foundation was increasing that fund to $1 billion.

The new examples in the proposed regulations demonstrate several points:

  • A PRI may extend to a variety of charitable purposes, such as promoting the arts, advancing science or combating environmental deterioration.
  • An investment that funds overseas activities may further the accomplishment of charitable purposes and qualify as a PRI.
  • The existence of a high potential rate of return on an investment does not preclude the investment from qualifying as a PRI.
  • A private foundation’s acceptance of an equity position in conjunction with making a loan does not necessarily prevent the investment from qualifying as a PRI.
  • A private foundation’s provision of credit enhancement, such as a guarantee agreement, can qualify as a PRI.

In addition, loans and capital may be provided to individuals or entities that are not themselves within a charitable class if they further a charitable goal. An example of this would be an investment in a for-profit drug company that develops a product for distribution at low cost to treat a disease endemic in children in an impoverished country.

According to the Corporate & Securities Law Blog of the law firm Sheppard Mullin Richter & Hampton LLP, PRIs receive several types of special tax treatment:

  • They are excluded from the assets private foundations take into account when calculating their distributable amount for the taxable year.
  • They are excluded from treatment as business holdings subject to excise tax.
  • They are generally treated as qualifying distributions for purposes of private foundations’ distribution requirements.
  • They do not constitute taxable expenditures as long as the private foundation exercises that expenditure responsibility when required.

The proposed regulations will become final when they are published in the Federal Register. In the meantime, the IRS says, private foundations can rely on the examples.

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