The IRS has released Notice 2015-62 (the Notice), giving guidance to private foundations making mission-related investments or MRIs. The Notice clarifies that a private foundation and its managers will not be fined under the jeopardizing investment rules for making mission-related investments that may generate lower returns and do not qualify under the safe harbor for program-related investments so long as such investments are made with ordinary business care and prudence.
Code Section 4944, known as the jeopardizing investment restriction, limits private foundations’ participation in high-risk investments. That section penalizes private foundations and their managers that invest any amount in such a manner as to jeopardize the carrying out of any of its exempt purposes.
There is an exception to this rule for program-related investments or PRIs. The Internal Revenue Code defines PRIs as investments, the primary purpose of which is to accomplish one or more [exempt] purposes . . ., and no significant purpose of which is the production of income or the appreciation of property.
Foundations are required to expend approximately 5% of their assets for charitable purposes each year. The other 95% is invested to generate distributable income for future years. Historically, foundations have struggled with the idea of making riskier investments that further their charitable purposes, but do not qualify as a PRI because a significant purpose of the investment is the production of income or the appreciation of property.
This tension has led to perverse incentives to invest in safe investments that post reliable returns even if the companies are working against a foundation’s mission (e.g., harming the environment, using sweatshop labor, damaging public health, etc.) Thus, a foundation could find 5% of its assets working toward its mission and the other 95% working against its mission.
The Notice makes clear that private foundation investments will not be considered jeopardizing investments so long as . . . foundation managers exercise ordinary business care and prudence under the circumstances prevailing at the time the investment is made in providing for the long-term and short-term financial needs of the foundation to carry out its charitable purposes.
The Notice acknowledges the Treasury Regulation’s list of factors that managers may consider when making investment decisions is not exhaustive and that an asset’s special relationship to the organization’s mission is an appropriate factor to consider. The Notice further provides that Foundation managers are not required to select only investments that offer the highest rates of return, the lowest risks, or the greatest liquidity. Rather, foundation managers taking an asset’s relationship to its mission into account in making investment decisions will be protected so long as they exercise ordinary business care and prudence under the facts and circumstances prevailing at the time of the investment.
This standard is consistent with the investment standards under the Uniform Prudent Management of Institutional Funds Act (UPMIFA) a version of which most states have adopted. UPMIFA expressly permits charitable organization’s to consider an asset’s special relationship or value to the organization’s charitable purposes in properly managing and investing the organization’s assets.
This Notice should give comfort to many private foundations and clear the way for more advanced thinking about how the other 95% of their assets are being utilized.
The Notice will give comfort to many public charities as well. Due to the lack of guidance for public charities making MRIs, public charities often look to the rules applicable to more tightly regulated private foundations. Hopefully, this new guidance will encourage more private foundations and public charities to engage in impact investing.
Ellis Carter is a nonprofit lawyer with Caritas Law Group, P.C. Ellis advises nonprofit and socially responsible businesses on corporate, tax, and fundraising regulations. Ellis is licensed to practice in Washington and Arizona and advises nonprofits on federal tax and fundraising regulations nationwide. Ellis also advises donors with regard to major gifts. To schedule a consultation with Ellis, call 602-456-0071 or email us through our contact form.