Proposed Regulations provide helpful new examples of “program-related investments”

As repeatedly promised in its work plan, the IRS recently issued Proposed Regulations containing several new examples of investments that qualify as a “program-related investment” (a “PRI”) for purposes of avoiding potential characterization as a “jeopardizing investment,” which could result in the imposition of excise taxes on a private foundation and its managers under Section 4944 of the Code. The proposed regulations can be found at 77 F.R. 23429 (April 19, 2012).

Section 4944 imposes excise taxes on a private foundation that makes a “jeopardizing investment” and on the foundation managers who knowingly participate in the making of the investment. A jeopardizing investment is made when, based on the facts and circumstances at the time the investment is made, the foundation managers fail to exercise ordinary business care and prudence in providing for the long-term and short-term needs of the foundation to carry out its exempt purposes. An investment that qualifies as a PRI, however, will not be characterized as a jeopardizing investment and will not trigger the Section 4944 excise tax. A PRI is any investment made with the primary purpose of carrying out charitable, religious, educational or similar purposes as long as the production of income is not a significant purpose of making the investment and the attempt to influence legislation or participate or intervene in any political campaign is not any purpose of making the investment.

The current regulations (which were promulgated in 1972) contain nine examples of investments that would qualify as PRIs, but the investment examples are limited in scope and fail to address many current investment practices. The Treasury Department and the IRS stated in the accompanying notice that the nine new examples are not intended to modify the existing rules governing PRIs, but rather are intended to fill in the gaps left by the current examples. Importantly, private foundations will be permitted to rely on these new examples prior to their finalization. Specific gaps and ambiguities in the current examples that the new examples are intended to address include clarification that:

  • an activity conducted in a foreign country furthers a charitable purpose if the same activity would further a charitable purpose if conducted in the United States;
  • the charitable purposes served by a PRI are not limited to situations involving economically disadvantaged individuals and deteriorated urban areas (which happen to be the types of situations discussed in the current examples);
  • the recipients of PRIs need not be within a charitable class if they are the instruments for furthering a charitable purpose;
  • a potentially high rate of return does not automatically prevent an investment from qualifying as a PRI;
  • PRIs can be achieved through a variety of investments, including loans to individuals, tax-exempt organizations and for-profit organizations, and equity investments in for-profit organizations;
  • a credit enhancement arrangement may qualify as a PRI; and
  • acceptance by a private foundation of an equity position in conjunction with making a loan does not necessarily prevent the investment from qualifying as a PRI.

Notably, PRIs are also accorded preferential treatment under other provisions of the Code. For example, a PRI is excluded from the assets that a private foundation must take into account when determining the annual “distributable amount” for purposes of avoiding the excise tax imposed on a foundation’s undistributed income under Section 4942 of the Code. Further, PRIs do not constitute “taxable expenditures” and thus are not subject to the excise tax under Section 4945 of the Code as long as a private foundation exercises certain expenditure responsibilities. Accordingly, while the IRS notes in the accompanying notice that the discussion in the new examples is limited to the impact of Section 4944 on the facts described therein, the examples will be helpful to those in the private foundation community for purposes of determining whether an expenditure may qualify for preferential treatment under other provisions of the Code as well.

The proposed regulations do not address low-profit limited liability companies.