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Financial Planning > Charitable Giving > SRI Impact Investing

IRS Removes a Tax Barrier to Impact Investing for Foundations

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Foundations that want to make impact investments can breathe easier — and ramp up their commitments — following the Internal Revenue Service’s recent announcement that mission-related investments should not automatically be subject to a tax.

The Chronicle of Philanthropy reported the agency’s new rule on Friday.

The IRS taxes foundations on investment gains made when their investment officers do not use “ordinary business care and prudence” to protect a grant maker’s long-term financial needs.

With its new rule, the IRS now holds that mission-related investments do not necessarily jeopardize a foundation’s financial future. “Only a jeopardizing investment is subject to tax under section 4944,” the IRS said.

The agency said foundation managers were not required to select only investments that offer the highest return, lowest risks or greatest liquidity, though they must exercise the ordinary business care and prudence in making investment decisions that support, and do not jeopardize, the furtherance of the private foundation’s charitable purposes.

Sustainable, responsible and impact investing in the U.S. grew by 76% between 2012 and 2014 to $6.6 trillion as more individuals and institutions sought to align their financial return goals with their social and environmental objectives, according to a report by the US SIF Foundation.

Foundations that purport to engage in impact investing, however, have held back, allocating a median 2% of their endowments toward impact investing, and just 0.5% of program/grant budgets to the activity, according to a poll by the Center for Effective Philanthropy.

David Wood, director of the Initiative for Responsible Investment at Harvard University, told The Chronicle that investment managers had raised fear of the tax as a “veto point” to object to social investments.

Wood called the IRS’s announcement a “big deal” because it acknowledged that an endowment was a tool to achieve a mission and not simply a financial engine propelling a foundation’s programs.

The Chronicle reported that the Kresge Foundation just announced it would put $350 million, 10% of its endowment, into impact investing by 2020. This is expected to jump-start program-related investments among foundations, especially in light of the new IRS rule.

A Kresge official said the agency’s announcement had not influenced its decision, as the foundation had been amassing expertise in social investing and had already decided to allocate more of its resources to investing.

In 2014, according to the report, Kresge made some $20 million in social investments by issuing low-interest debt and equity to nonprofit groups and by offering loan guarantees to businesses aligned with its mission.

— Check out 5 Challenges for Socially Responsible Investing: BNY Mellon on ThinkAdvisor.


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