The past few years have seen a marked push by younger-generation leaders in corporate America to adopt investment and marketplace strategies that emphasize combining social good with the pursuit of financial return. The problem for some private foundations who may have wanted to participate in “socially responsible investments” (SRI) is that such investments could be deemed to jeopardize the foundation’s exempt status, leading to an excise tax. But the IRS has lessened that concern with new guidance.
Previously, managers of private foundations may have held back pursuing certain investment opportunities that aligned with its organizational convictions because of the legal duty to exercise ordinary business care and prudence in carrying out investment strategies. Under this legal theory, managers must be cognizant of expected returns from various investment opportunities, generally choosing options with the best return, and to avoid high risk ventures. The concern Congress and the IRS have had in the tax-exempt realm is that certain investments could jeopardize the ability of a foundation to carry out its stated tax exempt purposes. Thus, IRC Code section 4944 imposes both an excise tax on a foundation that invests in any deemed “jeopardizing” investments, as well as on the foundation manager who participates in such decisions.
Recently, in Notice 2015-62, the IRS carved out space for private foundations to engage in some socially-responsible investments without fear of incurring an excise tax. The IRS noted that section 4944(c) provides an exception to the “jeopardizing investment” prohibition for program-related investments (PRI) that are made by a foundation specifically to carry out its charitable purposes. Therefore, the IRS was comfortable in extending similar protection to mission-related investments, which are not PRI because they still have a significant purpose of producing income or property appreciation. But the IRS stated that in exercising ordinary business care and prudence in deciding which investments to make, managers can, within bounds, take into account how an investment furthers the foundation’s charitable purposes using an “all relevant facts and circumstances” approach.
This guidance lifts the burden somewhat from managers, because managers are no longer required to choose only investments that offer the highest rate of return, greatest liquidity, and lowest risks. Of course, a manager still cannot embark on an investment strategy that expressly jeopardizes the foundation’s long-term and short-term financial needs. But the IRS’s move aligns the federal tax rules with the investment standard present in many states – the Uniform Prudential Management of Institutional Funds Acts — that allow consideration of an organization’s charitable purposes in managing its assets.