On September 15, 2015, the IRS released Notice 2015-62, Investments Made for Charitable Purposes, which may provide comfort to private foundations about making mission-related investments with reasonable business care without violating the jeopardizing investments laws. It is hoped that this guidance will catalyze greater impact investing by foundations using their endowment assets.

Mission-Related Investments

While a mission-related investment or MRI is not currently defined by the Internal Revenue Code or Treasury Regulations, it is generally considered to be an investment for both a financial return and a social impact return (more specifically, one that advances the particular mission of the investor). In some cases, there may be no need to balance those potentially competing concerns. But in many cases, the investor will need to balance at least short-term financial return with the social impact return. Some simple examples of MRIs include a purchase of equity in a company creating jobs in economically disadvantaged communities, a loan to an organization distributing essential resources in developing countries, and an investment in an alternative energy company.

See Mission-Related Investing: Legal and Policy Issues to Consider Before Investing (MacArthur Foundation)

Jeopardizing Investments

According to the IRS: “Jeopardizing investments generally are investments that show a lack of reasonable business care and prudence in providing for the long- and short-term financial needs of the foundation for it to carry out its exempt function.”

Substantial penalty taxes may be imposed on private foundations that make jeopardizing investments pursuant to Section 4944 of the Internal Revenue Code. The foundation may be subject to a first-tier tax of 10% of the relevant amount so invested for each year in the taxable period. A 25% second-tier tax may be imposed if the violation is not corrected within the taxable period. Foundation managers (including directors) who knowingly participated in making that investment may also be subject to a first-tier tax of 10% and a second-tier tax of 5% of the relevant amount.

The general approach to avoiding the tax on jeopardizing investments is to invest in a reasonably diversified portfolio of assets rather than in a small number of speculative investments. The IRS provides: “In deciding whether the investment of an amount jeopardizes carrying out the exempt purposes, a determination must be made on an investment-by-investment basis taking into account the foundation’s portfolio as a whole.”

There is a specific exclusion from the jeopardizing investment prohibition for program-related investments (PRIs). Generally, a PRI is an investment in which (1) the primary purpose is to accomplish one or more charitable purposes; (2) the production of income or the appreciation of property is not a significant purpose; and (3) lobbying or electioneering is not a purpose. A PRI might take the form of a loan to a charity or a loan to, or equity investment in, a business entity for a charitable purpose, such as, to develop or distribute a lifesaving drug for use in developing countries that would not otherwise be commercially viable.

See Private Foundation – “Jeopardizing investments” defined (IRS)

The New Guidance

According to the IRS, Notice 2015-62 “confirms that under section 4944 of the Internal Revenue Code, private foundation managers may consider the relationship between a particular investment and the foundation’s charitable purpose when exercising ordinary business care and prudence in deciding whether to make the investment.”

In other words, it’s not a lack of reasonable business care and prudence (and therefore not a jeopardizing investment) merely because the private foundation managers consider the social impact return related to the foundation’s mission as well as the financial return the investment may produce in selecting an investment.

Prior to this guidance, it was uncertain whether private foundation manager could select an investment whose primary purpose was to accomplish one or more charitable purposes where the production of income or the appreciation of property was also a significant purpose, making the investment fall outside of the definition of a PRI. The Notice specifically states:

Foundation managers are not required to select only investments that offer the highest rates of return, the lowest risks, or the greatest liquidity so long as the foundation managers exercise the requisite ordinary business care and prudence under the facts and circumstances prevailing at the time of the investment in making investment decisions that support, and do not jeopardize, the furtherance of the private foundation’s charitable purposes.

Notably, this conforms the standard under federal tax laws with the state prudent investment laws under the Uniform Prudent Management of Institutional Funds Act (UPMIFA), “which generally provide for the consideration of the charitable purposes of an organization or certain factors, including an asset’s special relationship or special value, if any, to the charitable purposes of the organization, in properly managing and investing the organization’s investment assets.”

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Michele Berger: On a webinar hosted by Mission Investors Exchange and the Council on Foundations titled “Impact Investing and Private Foundations: New Guidance from the IRS and Its Implications for the Field“, the following tips were discussed.

While foundations may now enjoy more comfort and less ambiguity when making impact investments, foundation managers must still exercise the same ordinary business care and prudence when making such investments. Some suggestions for implementing a process for MRIs include:

• having a separate portfolio for impact investments;
• creating a policy statement within the organization that addresses how to make MRIs;
• looking at what the foundation sees as its purposes (examining Articles of Incorporation, the mission statement, programs) and measuring how the investment is tied to those purposes;
• documenting the decision and rationale for the investment in meeting minutes or a summary of the investment;
• making sure the board and senior management is apprised of such decisions and processes; and
• consulting counsel.

See New IRS Rule Likely to Make Impact Investing Easier, The Chronicle of Philanthropy