New guidance permits private foundations to consider charitable purposes when making investments with a substantial purpose of capital appreciation or the production of income. 

The Internal Revenue Service (IRS) recently issued guidance explicitly aligning the prudent-investor standard for jeopardizing investments under Internal Revenue Code § 4944 with state standards for charitable investments under the Uniform Prudent Management of Institutional Funds Act (UPMIFA). Consistent with the provisions of UPMIFA, IRS Notice 2015-62 confirms that foundation managers may consider the relationship of a proposed investment to the foundation’s charitable purpose when determining whether an investment is prudent. Under this standard, private foundations may make prudent, non-jeopardizing investments that further their charitable purposes even if they offer a somewhat lower expected rate of return than might otherwise be achieved. These types of investments are frequently referred to as “mission-related investments” (MRIs).

The following describes the new guidance on MRIs and provides some practical considerations for private foundations considering whether to include MRIs in their investment portfolios.

Notice 2015-62

Section 4944 imposes an excise tax on a private foundation that invests “any amount in such a manner as to jeopardize the carrying out of any of its exempt purposes.” The IRS’s definition of jeopardizing investments explicitly excludes program-related investments (PRIs), which are investments made for the primary purpose of accomplishing a foundation’s exempt purposes rather than producing income or appreciation of capital. There is no such exception for MRIs, which are made to generate a profit and to further a foundation’s mission. Since MRIs may offer lower returns than non-MRI investments, some have questioned whether this could cause them to be treated as jeopardizing investments.

The Treasury Regulations under Section 4944 do not address this issue. They provide that an investment will be considered jeopardizing if a foundation’s managers fail to exercise ordinary business care and prudence, but the regulations are silent on whether the relationship of an investment to a foundation’s mission is also a permissible consideration.

IRS Notice 2015-62, issued September 16, 2015, puts this issue to rest. The Notice makes it clear that foundation managers may consider the relationship between an investment and the foundation’s mission in making prudent, profit-driven investments. The Notice also indicates that MRIs will not be considered imprudent because they offer an expected return that is less than what could be earned on other investments. In that regard, the Notice provides that

[A] private foundation will not be subject to tax under Code section 4944 if foundation managers who have exercised ordinary business care and prudence make an investment that furthers the foundation’s charitable purposes at an expected rate of return that is less than what the foundation might obtain from an investment that is unrelated to its charitable purposes.

Notice 2015-62 brings the federal tax rules in line with the state standards under the UPMIFA, which all states except Pennsylvania have adopted.

UPMIFA provides a uniform set of guidelines for charitable organizations concerning the management and investment of charitable funds, and says that an asset’s special relationship or special value, if any, to the charitable purposes of the organization is one of the factors that a foundation may prudently consider in making an investment decision.

Practical Considerations for Foundation Managers

Many foundation managers and their legal advisors have been comfortable for some time that MRIs made in accordance with the UPMIFA standards will not be considered jeopardizing investments under Section 4944. For these foundations, Notice 2015-62 will not cause any major shifts in their investment practices. However, Notice 2015-62 may prompt other foundations not already making MRIs to consider adding this tool to their investment portfolios.

When making MRIs, foundation managers should keep in mind the following considerations:

  • Foundations should review and, if necessary, update their investment guidelines to reflect UPMIFA standards adopted in their respective states.
  • When deciding whether to make an MRI, a foundation should take care to document the relationship between the proposed investment and the foundation’s charitable purposes, as well as any other considerations in deciding whether to make the investment.
  • Foundations have an obligation to monitor the financial performance of all investments and, in the case of MRIs, foundations also should monitor and take into account mission impact.