IRS Issues Rules Favorable to Foundations on Program-Related Investments

The Internal Revenue Service has issued new regulations designed to encourage private foundations to make investments in areas such as education, health, and the environment that can result in societal benefits and simultaneously generate income.

The new regulations have “sent a clear message that private foundations can deploy a wide array of financial tools to achieve their charitable goals,” David Wilkinson, director of the White House Office of Social Innovation and Civic Participation, said in a statement issued Thursday.

The new regulations are set to go into effect on Monday.

Foundations have long treated program-related investments as part of their grant-making budget for tax purposes. As such, those investments are counted as part of the annual distribution foundations must make each year. To maintain their favored tax treatment, foundations must pay out 5 percent of their assets annually.

Many foundation leaders have pushed the IRS to clarify what kinds of investments qualify.

In its previous guidance on the subject, the IRS included examples of program-related investments that focused on domestic charitable work designed to help economically disadvantaged individuals and deteriorated urban areas.

The new guidance adds nine more examples of investments, including some made in other countries and to entities that are not charities. The new examples include investments that may potentially earn a high rate of return.

For instance, the IRS laid out how a foundation could support the development of vaccines in a developing region, while earning a profit. To do so, it could strike an investment agreement involving a company that was hesitant to develop and distribute the drug for less than market rate in poor countries. The IRS stipulated that the drug maker could step up its price “to those who can afford it,” as long as it published research on the vaccine’s development. And the foundation could benefit from its investment — which was made to promote scientific research in the public interest — without negative tax consequences.

The guidance, said Mr. Wilkinson, “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.”

Matt Onek, chief executive at Mission Investors Exchange, a network of foundation and impact-investing professionals, said the guidance provided a “comfort level” that the IRS won’t penalize grant makers for making a broader range of deals.

“These new examples really provide greater assurance to foundation leaders, especially those will small legal staffs,” he said.

Additional Guidance

The new regulations follow guidance the IRS issued in September designed to clarify the tax treatment of non-PRI investments that advance a foundation’s charitable mission even if it offers a lower rate of return or higher risk than other available investments that serve no charitable purpose.

Foundation managers had long feared the IRS would treat those investments as “jeopardizing” investments that put grant makers’ endowments at risk, which would have had unfavorable tax implications. But the IRS issued draft guidance favorable to foundations in that instance as well.