Program-related investments (PRIs)1 are an exciting tool to make new funds available to social enterprises. At their core, PRIs are foundation investments that “the primary purpose of which is to accomplish [the foundation’s exempt purpose],”2 and exempt foundations from the tax burdens typically associated with investing. This provision allows foundations to provide loans to social enterprises or investments for equity rather than merely offering grants. As such, foundations have more money to invest in social enterprises.
What is a foundation?
To understand the PRI exemption, it is first important to recognize who may qualify for this exemption. PRIs are only available to private foundations. Private foundations are all organizations that qualify for 501(c)(3) tax-exempt status, excluding public charities. The rules for private foundations also apply to charitable trusts, though they are not tax exempt. All 501(c)(3) organizations are presumed to be private foundations unless an organization informs the IRS otherwise.3
Why is an exemption needed?
As mentioned above, PRIs are an exemption to the standard private foundation investment rules. When an investment is not a PRI, a foundation could be liable for significant taxes.4 Specifically, both the foundation could be liable for a 10% tax of the initial investment. Additionally, the management who made the investment could be held personally liable for a 10% tax of the investment. If the violating investment is not remedied, the foundation could be held liable for an additional 25% tax and the management for an additional 5% tax.5
Fortunately, PRIs provide an exception to this harsh rule. If an investment is “program-related,” the foundation may make that investment without tax penalty.6
What qualifies as a program-related investment?
For a foundation’s investment to qualify as “program-related,” it must meet three criteria.
The investment must:
- Have a primary purpose to accomplish one or more of the foundation’s exempt purposes,
- Not have production of income or appreciation of property as a significant purpose, and
- Not be for the purpose of influencing legislation or taking part in political campaigns on behalf of candidates.7
One important guide for determining if an investment is furthering the foundation’s exempt purpose or if its significant purpose is the production of income or appreciation of property is whether an investor, who invests exclusively for profit, would make the investment under the same terms.8 If the investor would make that investment, it likely does not advance the foundation’s exempt purpose sufficiently.
Generally, an investment that qualified as a PRI will continue to be so if there is a change in the terms of the arrangement. If, however, there is a critical change in circumstances, the investment might no longer qualify as a PRI.9
Benefits to social enterprises and foundations
PRIs are really beneficial for both social enterprises and foundations. As mentioned above, PRIs make it possible for social enterprises to have access to more foundation-sourced capital. This is because, unlike grants, foundations can offer capital from the returns on investments.
PRIs are also very beneficial for the foundations. Foundations are required to distribute approximately 5% of their total assets per year. PRIs count toward this percentage. This means that foundations can get a return, even if small, on their distributions. Finally, this is important because the PRIs are not diverted from a foundation’s traditional investments, meaning they are not shrinking a foundation’s endowment. Ultimately, PRIs allow for foundations to do more to advance their charitable purpose with the same amount of money.
- Program-Related Investments, Internal Revenue Service (Apr. 21, 2016), https://www.irs.gov/charities-non-profits/private-foundations/program-related-investments.
- Nicole Motter, Why Program-Related Investments Are Not Risky Business, Forbes (Feb. 21, 2013), http://www.forbes.com/sites/ashoka/2013/02/21/why-program-related-investments-are-not-risky-business/#755741851f8e.
- Exception for Program-Related Investments, 26 C.F.R. § 53.4944-3(b). This section has several examples of PRIs.
- Debra Schwarz, Webinar: PRI/MRI 101: Intro to Program Related and Mission Related Investments, Jewish Funders Network (Oct. 14, 2015), https://www.youtube.com/watch?v=0o-Fog3P1h0&feature=youtu.be.
This page was written by Erika Dunyak, a Sustainable Economies Law Center Intern.
- **Note: This page covers only program-related investments. Mission-related investments are distinct from program-related investments and do not have a specific definition within the tax code. Importantly, mission-related investments may be used by anyone and are essentially synonymous with impact investments. A common example of a mission-related investment is to divest an endowment from fossil fuels and instead invest in sustainable energy technologies. ↩
- 26 U.S.C. § 4944(c). ↩
- Private Foundations, Internal Revenue Service (Aug. 30, 2016), https://www.irs.gov/charities-non-profits/charitable-organizations/private-foundations. ↩
- 26 U.S.C. § 4944. ↩
- 26 U.S.C. § 4944. ↩
- 26 U.S.C. § 4944(c). ↩
- 26 C.F.R. § 53.4944-3. ↩
- 26 C.F.R. § 53.4944-3(a)(2)(iii). ↩
- 26 C.F.R. § 53.4944-3(a)(3). An example of a critical change in circumstances is when the change serves an illegal purpose. ↩