IRS Releases Final Regulations on Private Foundation Program-Related Investments

| 4/28/2016

The IRS released final regulations that provide current examples illustrating the types of investments that qualify as program-related investments (PRIs) for private foundations. The regulations are effective on or after April 25, 2016, and are a welcome effort by the IRS and Treasury. Although private foundations have evolved over the past 50 years, tax guidance regarding PRIs has remained stagnant. The final regulations follow an April 19, 2012, Notice of Proposed Rulemaking, with various changes to address comments received.

PRIs are investments that significantly further a private foundation’s exempt activities. They are not necessarily good business investments because the tax law provides that no significant purpose of the investment can be the production of income or the appreciation of property. PRIs receive favorable treatment under the private foundation excise tax rules in several respects. Among other things, PRIs are treated as qualifying distributions under IRC Section 4942 when determining a private foundation’s minimum distribution requirement, and they generally do not constitute taxable expenditures under IRC Section 4945. Having more clarity surrounding the PRI rules ostensibly expands the types of programmatic investment activities in which private foundations may comfortably engage.

Nine new PRI examples are added to a list of 10 existing examples that have been part of the regulations since 1972. Existing guidance has been criticized by the private foundation community as not being reflective of modern foundation operations. Specifically, the long-standing PRI examples focused on domestic situations principally involving economically disadvantaged individuals and deteriorated urban areas, offering foundations little assistance in analyzing investments that further their exempt purposes in foreign countries, that may earn a high potential rate of return, that take the form of an equity position in conjunction with a loan, or that represent other complex situations.

Private foundations should refer to the final regulations for details of the new examples, including the following “statement of principles”:

  • “An activity conducted in a foreign country furthers an exempt purpose if the same activity would further an exempt purpose if conducted in the United States.
  • “The exempt purposes served by a PRI are not limited to situations involving economically disadvantaged individuals and deteriorated urban areas.
  • “Recipients of PRIs need not be within a charitable class if they are the instruments for furthering an exempt purpose.
  • “A potentially high rate of return does not automatically prevent an investment from qualifying as program-related.
  • “PRIs can be achieved through a variety of investments, including loans to individuals, loans to tax-exempt organizations and for-profit organizations, and equity investments in for-profit organizations.
  • “A credit enhancement arrangement may qualify 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.”

The preamble to the regulations notes that the IRS intends to post these guiding principles on its website so grant-making organizations can access them readily. 

A topic not addressed in the regulations is PRIs in the form of investments in a partnership. The IRS and Treasury are considering whether to address such investments through the issuance of a revenue ruling. In the meantime, private foundations may refer to the analysis of investments by section 501(c)(3) organizations in partnership interests set forth in Revenue Ruling 2004-51 and Revenue Ruling 98-15.

The guidance has been welcomed by the private foundation community. While the guidance does not address every potential scenario – commenters had even requested guidance regarding circumstances under which PRIs may result in impermissible private benefit, which would be a section 501(c)(3) issue rather than a private foundation excise tax issue – it has offered private foundations a clearer path to investment analysis in the modern world.

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