Building ladders of opportunity for all Americans requires a focus on outcomes, creative thinking, willing partners, and a variety of financial resources. Through new guidance and regulations from US Treasury Department over the past six months, the Obama Administration has sent a clear message that private foundations can deploy a wide array of financial tools to achieve their charitable goals.
When we think about a private foundation, an institution operated exclusively to further its charitable purpose, we often think about philanthropy’s ability to make grants, convene, and build partnerships, but don’t always consider its investment capabilities. Traditionally, a foundation has viewed its financial resources as two distinct pots of capital: funds set aside for grants that further charitable purposes, but are not repaid; and funds dedicated to investments, which provide a financial return and maintain the value of the endowment as an ongoing source for future philanthropic activity. Increasingly, foundations are realizing the benefits of tools for funding charitable projects that do not neatly fall in one category or the other. In recent years, foundation leaders, philanthropy associations, and impact investing coalitions have sought guidance regarding how they can make investments for both charitable purposes and financial returns while staying within the tax rules for foundation investments.
Today, the US Treasury Department and IRS finalized regulations that make it easier for private foundations to make Program-Related Investments (PRIs), which are investments – such as loans, loan guarantees, or equity investments – made primarily to accomplish a foundation’s charitable purposes, and not to generate financial returns. PRIs are one example of such a financing tool that is not a grant, nor just an investment, but is in some ways like both. Some private foundations have a long history of using PRIs to make charitable investments that are intended to produce significant charitable returns, but generally negligible financial returns. A private foundation’s PRIs count towards the annual distribution that the foundation must make each year and receive other tax-favored treatment. Therefore, PRIs have typically been treated as a part of a foundation’s grantmaking budget.
The PRI regulations, proposed in 2012 and finalized today, provide nine new examples illustrating how a foundation can use PRIs to advance its charitable purpose. Many foundations have had misperceptions of the rules governing PRIs and many believed that expensive processes, such as specific IRS approvals or legal opinions, were necessary to safely use this tool. The new regulations, which closely follow the proposed regulations, illustrate the wide range of investments that might qualify as PRIs, including those accomplishing a variety of charitable purposes and utilizing a variety of financial arrangements. Thus, today’s guidance reassures foundations that a wide range of investments can qualify as PRIs and reduces the perceived need for legal counsel or IRS rulings in many cases.
Beyond PRIs, some private foundations are making prudent investments for both charitable purposes and financial returns. As these mission-related investment practices gained popularity, philanthropy and impact investing leaders questioned whether it was permissible to make an investment for both a charitable purpose and financial gain through the foundation’s investment portfolio (rather than its grantmaking budget, as is generally the case for PRIs). Some indicated to the Administration that there was a need to provide clarity on this type of “double bottom line” investing.
Last fall, Treasury and the IRS issued guidance clarifying that private foundations could make prudent mission-related investments. This new guidance assures private foundation leaders and investment managers that it is possible to make a prudent investment that advances the foundation’s charitable purpose, even if the investment offers a lower rate of return, higher risk, or lower liquidity than alternative investments that do not further charitable purposes. Specifically, the guidance provides that when deciding how to invest the foundation’s assets, a foundation manager can factor in how the anticipated charitable outcomes from the investment might further the foundation’s mission in addition to the financial returns that are typically considered. Thus, a foundation may prudently choose to make investments that provide both a charitable and a financial return without fear of facing a tax penalty.
These two actions by Treasury should remove confusion and signal to the field that a foundation can use its financial assets in a variety of ways to accomplish its mission. With increased comfort about using a variety of prudent financial tools, private foundations can continue to help create safe communities, strengthen schools, and achieve other charitable goals that make our country a place where everyone has the opportunity to succeed.