Program-Related Investment (PRI)

A program-related investment is an investment by a private foundation that qualifies for the exception at Internal Revenue Code section 4944(c), so it is not treated as an investment that jeopardizes the carrying out of the foundation's exempt purposes. In practice it is usually a below-market loan, a loan guarantee, a deposit, or an equity stake in an enterprise whose activity the foundation wants to see happen.

The regulation at 26 CFR 53.4944-3(a)(1) sets out three characteristics, and all three must be present. The primary purpose of the investment must be to accomplish one or more of the purposes described in section 170(c)(2)(B), the ordinary list of charitable, religious, educational, scientific and literary purposes. No significant purpose may be the production of income or the appreciation of property. And no purpose may be to accomplish one or more of the purposes described in section 170(c)(2)(D), which is the provision about influencing legislation. The third condition is the one most summaries omit, and it is a condition rather than a footnote.

The test is comparative, not a feelings test. Under 26 CFR 53.4944-3(a)(2)(iii), in deciding whether a significant purpose is income or appreciation, "it shall be relevant whether investors solely engaged in the investment for profit would be likely to make the investment on the same terms as the private foundation." That is the practical question: would a commercial lender have written this loan at this rate to this borrower? If the answer is no, the concessionary element is evidence the purpose is charitable. The same subdivision adds the mirror-image protection: the fact that an investment turns out to produce significant income or capital appreciation is not, by itself, conclusive evidence of a disqualifying purpose. An investment that succeeds does not retroactively stop being program-related.

There is also a but-for test. Paragraph (a)(2)(i) treats an investment as made primarily for charitable purposes if it "significantly furthers the accomplishment of the private foundation's exempt activities and if the investment would not have been made but for such relationship between the investment and the accomplishment of the foundation's exempt activities." So the investment has to be traceable to the foundation's own program, not merely compatible with it.

The payout consequence is the reason foundations use the tool. Under 26 CFR 53.4942(a)-3(a)(2)(i), a qualifying distribution means "any amount (including program related investments, as defined in section 4944(c), and reasonable and necessary administrative expenses) paid to accomplish one or more purposes described in section 170(c)(1) or (2)(B)." A grant and a program-related investment therefore count the same way toward the annual distribution the foundation owes, even though the foundation expects the investment back and does not expect the grant back.

And the recycling is accounted for in the payout arithmetic itself. Because the outlay already earned distribution credit, the statute takes that credit back when the money returns. Section 4942(d)(1) defines the distributable amount as "the sum of the minimum investment return plus the amounts described in subsection (f)(2)(C)," and subsection (f)(2)(C)(i) is "amounts received or accrued as repayments of amounts which were taken into account as a qualifying distribution." A repayment therefore does more than fail to earn credit a second time: it increases what the foundation must distribute in the year the money is received, on top of the ordinary minimum investment return. Form 990-PF carries the adjustment on a line of its own, "Recoveries of amounts treated as qualifying distributions." One thing worth knowing if you go looking: the regulation at 26 CFR 53.4942(a)-2 has not caught up, because its own definition of the distributable amount predates the 1984 amendment that added the clause, so the regulation alone does not show the rule.

A program-related investment can stop being one, and there is a grace period. Paragraph (a)(3)(i) says the classification survives changes in form or terms made primarily for exempt purposes, and that a change made for the prudent protection of the investment does not ordinarily cost the status. But a "critical change in circumstances" can end it, and where that happens the foundation is not subject to the section 4944(a)(1) tax "before the 30th day after the date on which such foundation (or any of its managers) has actual knowledge of such critical change in circumstances."

What it is not. A mission-related investment is a market-rate investment chosen partly for its alignment with the foundation's mission. It is a perfectly ordinary portfolio decision, it is not excepted by section 4944(c), and it earns no payout credit. The two terms are a contrast rather than synonyms, and using them interchangeably is the commonest error in this vocabulary. Impact investing describes an investor's posture and can be market-rate or concessionary; a program-related investment is a defined tax category available only to a private foundation.

The regulation's own examples are the clearest map of the territory, and they are worth reading in the source rather than paraphrasing loosely. Example 1 describes a below-market loan to a small business in a deteriorated urban area that conventional lenders will not fund on feasible terms. Example 11 describes funding the development of a vaccine for a disease affecting poor individuals in developing countries. Example 12 describes a recycling enterprise in a developing country. Examples 18 and 19 describe a deposit in a bank, and then a guarantee to that bank, to induce lending the bank would not otherwise do. The common thread is that the foundation supplies capital on terms the market will not, in service of an activity the foundation already funds.

A hypothetical shows the arithmetic of the payout credit. Suppose a foundation owes a distribution of $500,000 for the year. It makes $300,000 of ordinary grants and lends $200,000 to a nonprofit housing developer at 2 percent for five years, structured as a program-related investment. Its qualifying distributions for the year are $300,000 plus $200,000, or $500,000, and the requirement is met. Five years later the developer repays the $200,000. Under section 4942(d)(1) that repayment is added to the distributable amount for the year it is received, so if the foundation's ordinary requirement for that year is $520,000, it must distribute $520,000 + $200,000 = $720,000. The investment bought the foundation timing, not a reduction. All figures are hypothetical.

If the investment fails the three-prong test, section 4944 applies instead: an initial tax of 10 percent of the amount invested for each year in the taxable period on the foundation, and 10 percent on a foundation manager who participated knowing the investment jeopardized exempt purposes, unless the participation was not willful and was due to reasonable cause. If the investment is not removed from jeopardy within the taxable period, the additional taxes are 25 percent on the foundation and 5 percent on a manager who refused to agree to removal. Those percentages are fixed in the statute and are not adjusted for inflation.

Pros

• It earns the same payout credit as a grant, so a foundation can meet its annual distribution requirement with money it expects to see again.
• Repaid capital can be redeployed, which lets a fixed endowment support more total activity over time than grants alone.
• It reaches enterprises that grants cannot, including for-profit businesses, because the test is the purpose of the investment rather than the tax status of the recipient.
• A guarantee or a deposit can unlock commercial lending several times the size of the foundation's own exposure.
• Success does not disqualify it. The regulation says significant income or appreciation is not by itself conclusive evidence of a disqualifying purpose.

Cons

• The classification is a judgment made in advance about purpose, and losing it exposes the foundation and, separately, individual managers to excise tax.
• The lobbying prong is absolute. "No purpose" is a stricter standard than the "no significant purpose" applied to income and appreciation.
• Documenting the but-for relationship and the below-market terms takes legal and underwriting work a grant does not require.
• Repayment raises the distribution requirement for the year the money comes back, so the payout relief is timing rather than a permanent reduction.
• It is unavailable to individuals, donor-advised funds and public charities as a tax category, so a donor who likes the idea cannot simply do it personally.