Private foundations lost more than 20% of their assets during the economic crisis, according to the Foundation Center (see Foundation Growth and Giving Estimates, available at tinyurl.com/2vhk93e). At the same time, the demand for charitable services--and foundation dollars to support those services--increased significantly. The combination of these dynamics prompted many private foundations to consider new strategies to do more with less. Even today, as endowments slowly recover, foundations are increasingly pursuing ways to address societal needs while protecting their balance sheets.
The IRS and Treasury Department issued proposed regulations in 2012 (REG-144267-11) to make it easier for private foundations to do just that. The new guidance is intended to reduce transaction costs associated with program-related investments (PRIs), a type of charitable disbursement that enables foundations to make a positive impact m a financially savvy way Specifically, PRIs are investments made primarily to further the foundation's mission; the potential for financial gain must not be a primary driver of the decision to make the PRI (see "Capital With a Conscience," JofA, July 2008, page 54). Consequently, PRIs count toward foundations' mandatory annual payout requirement, just as traditional grants do. (For more on required distributable amounts, see "Advising Private Foundations," JofA, April 2008, page 36.) However, private foundations expect PRI recipients, unlike grant recipients, to repay the investment, possibly with interest. Once the money is repaid, foundations recycle the funds to other charitable projects, multiplying the impact of each philanthropic dollar.
The proposed regulations include nine new examples of permissible PRIs, doubling the number of examples that foundations can use to guide their PRI efforts. The new examples are more diverse in structure, location, and purpose. This issuance marks the first time in 40 years that the IRS has updated the PRI rules. While proposed regulations are generally not authoritative guidance, the IRS explicitly states that taxpayers may rely on these proposed regulations.
PRIs: A PRIMER Under Sec. 4944(c) and associated existing regulations, a PRI must primarily further one of the charitable purposes of Sec. 170(c)(2)(B) (religious, charitable, scientific, literary, educational, etc.) and may not be used for a political activity prohibited for exempt organizations under Sec. 170(c)(2)(D) (attempting to influence legislation or participating or intervening in a political campaign). It must not have as a significant purpose the production of income or appreciation of property (Regs. Sec. 53.4944-3(a)(1)).
An investment is made primarily to accomplish a charitable purpose under Sec. 170(c)(2)(B) if it significantly furthers the accomplishment of the foundation's exempt activities and would not have been made but for its relation to the foundation's exempt activities (Regs. Sec. 53.4944-3(a)(2)(i)). Therefore, an investment that qualifies as a PRI for one private foundation may not qualify for another, depending on the mission of each. In determining whether a significant purpose of an investment is the production of income or the appreciation of property, a relevant consideration is whether a traditional investor would make the same investment on the same terms (Regs. Sec. 53.4944-3(a)(2)(iii)).
The structure of a PRI is a function of project needs, prevailing market conditions, and the recipient's ability to generate sufficient cash flows with which to repay the foundation's investment. Most commonly, PRIs are created as below-market-rate loans to public charities. However, the regulations specify that the PRI recipient does not have to be a not-for-profit organization; a PRI in a for-profit business enterprise is permissible as long as the foundation makes the investment primarily to further its own mission. …