May 3, 2012; Source: JD Supra

The Internal Revenue Service has just released proposed regulations that aim to clarify the rules for program related investments (PRIs). The proposed regulations would tell foundations what kinds of PRIs might be characterized as a “jeopardizing investment” that could results in excise taxes on both the foundation and the foundation managers involved.

According to the author of this article, “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 purpose of the new regulations is really to update the examples of qualified PRIs. The current examples in the regs were developed in 1972, but new examples are needed due to advances in investment practices.

The regs don’t replace the existing nine examples, but “fill in the gaps.” For example, the new proposal addresses situations such as how overseas investments might qualify as PRIs, clarifies that PRIs need not be “limited to situations involving economically disadvantaged individuals and deteriorated urban areas,” states that PRI recipients “need not be within a charitable class if they are the instruments for furthering a charitable purpose,” indicates that “a potentially high rate of return does not automatically prevent an investment from qualifying as a PRI,” and notes that PRIs can include investments to “for-profit organizations and equity investments in for-profit organizations.”

The rules are not meant to address the legitimacy of the low profit limited liability corporation (L3C), but it isn’t hard to see why L3C proponents might be cheering about some of the classifications. Citing Marc Lane, a Chicago lawyer and proponent of L3Cs, an article in Forbes contends that, “if foundations were to pour money into these companies, then that could serve as an incentive for other investors to take the plunge.” In the “old” regulations, PRIs to L3Cs and other non-charitable entities were not prohibited, but without specific guidance, foundations either had to rely on “opinion of counsel” statements or the more difficult IRS “private letter rulings” to make sure that they weren’t stumbling into taxable jeopardizing investments. By expanding and clarifying the examples of acceptable PRIs, the IRS could make some of the risk easier to circumvent for foundation PRIs to and through L3Cs.

It is not hard to see that not only has the IRS looked to update its examples, but foundations with longstanding PRI notions have weighed in with examples for the IRS to consider, and the IRS has responded. For example, one of the examples is the idea of an “equity investment in a for-profit drug company made for the purpose of developing a vaccine to prevent a disease that predominantly affects poor individuals in developing countries,” an example that sounds very much like the kind of investment that has been coming from the Bill & Melinda Gates Foundation, which recently established a $100 million PRI fund.

The proposed regulation doesn’t explicitly talk about L3Cs, but it’s easy to see how the L3C movement would see itself helped if the proposed regulations get implemented.—Rick Cohen