Further your foundation’s purpose with program- and mission-related investments

Purpose-driven investing can help private foundations further their mission by reducing their tax burden and increasing cash flow. One of the most effective ways for organizations to do this is through program-related investments (PRIs) and, to a lesser extent, mission-related investments (MRIs).

Both types of investments are tax-exempt and offer foundations the opportunity to positively affect their communities and further their exempt purposes. However, there are significant differences between these investment classifications and several reasons why a foundation may choose to use one over the other.

This article is the fourth in a series taking an in-depth look at topics important to private foundations, including excise tax, excess business holdings, self-dealing, and private-operating foundations.

Jeopardizing investments

When private foundations make investments that aren’t profit driven, those investments can be classified as jeopardizing investments, which are investments that jeopardize an organization’s ability to carry out any of its exempt purposes.

Jeopardizing investments are subject to excise tax, so to avoid this classification, foundation managers must consider all of the relevant facts and circumstances for each investment, such as:

• Expected financial return, including equity and income
• Risk of rising and falling prices
• Need for diversification of investments, as related to the entire portfolio

It’s important to note that an investment can’t be classified as jeopardizing if it furthers a foundation’s mission — even if the expected rate of return is less than what could be earned if the money were invested elsewhere. Because of this rule, both PRIs and MRIs are exempt from this definition.

Program-related investments

An investment must possess the following characteristics to qualify as a PRI and satisfy a nonoperating foundation's distribution requirement:

• Accomplishing a charitable, educational, or similar goal that furthers the organization's exempt purpose is the investment’s primary purpose
• Earning income isn’t a significant reason for making the investment, meaning there’s no profit motive
• Influencing legislation or lobbying on behalf of anyone running for public office isn’t a purpose of the investment

PRIs are intended to improve conditions for economically disadvantaged populations and geographical areas. Accordingly, they don’t jeopardize a tax-exempt organization's exempt purpose — no matter how low the rate of return on the investment is. Examples of common PRIs provided to organizations and businesses:

• Low-interest loans to small businesses owned by individuals in a disadvantaged class when commercial loans with reasonable interest rates aren’t available
• Investments in businesses in poor areas, helping to revitalize the economy and create jobs
• Investments in not-for-profit organizations combatting deterioration in faltering communities

Advantages

PRIs are similar to grant-making activities. They also provide various advantages because they’re:

• Treated as qualifying distributions under IRC Section 4942 for the purpose of meeting a foundation's 5% minimum distribution requirements
• Excluded from assets taken into account when computing an organization’s 5% minimum distribution requirement
• Not subject to the excess business holding rules under IRC Section 4943
• Not treated as taxable expenditures as long as the organization exercises expenditure responsibility when required
• Not subject to jeopardizing investment rules because the investment’s significant purpose isn’t the production of income or appreciation of property

Mission-related investments

If an investment doesn’t meet the criteria for a PRI, a foundation can pursue an MRI classification. Even though an MRI doesn’t come with all of the advantages of a PRI, a foundation still benefits from not being assessed an excise tax on the investment’s value because it won’t be considered a jeopardizing investment.

As defined by the IRS in Notice 2015-62, MRIs are investments made with the dual purpose of generating income and furthering an organization’s exempt purpose. As such, an MRI provides an investor with both a social and financial return on investment. Profit can’t be the ultimate goal, but it can be a motivational factor. When making this determination, foundation managers should review the following factors:

• Expected financial return, including equity and income
• Risk of rising and falling prices
• Need for diversification of investments as related to the entire portfolio

Because of its profit motivation, an MRI runs a higher risk of being categorized as a jeopardizing investment. To make this determination, the IRS considers the investment on its own merits, although its relation to the entire portfolio is also taken into account. Once an investment is determined not to be a jeopardizing investment, it won’t be considered jeopardizing later — even if the investment returns less than expected results — and thus won’t be assessed an excise tax.