Announcing the Philanthropic Facilitation Act (H.R. 2832)

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1 Announcing the Philanthropic Facilitation Act (H.R. 2832) On July 25, 2013, Rep. Cory Gardner (R-CO) introduced the Philanthropic Facilitation Act (PFA) (H.R. 2832) which was written by Americans for Community Development and cosponsored by Jared Polis (D-CO). The bill amends sections of the Internal Revenue Code of 1986 relevant to PRIs (Program Related Investments) by Foundations. This section of the code embodies the gold standard of the IRS definition of a for profit performing a charitable function. The PFA will facilitate investment by foundations, other philanthropic organizations, and private impact investors in various for profit businesses which are carrying out a charitable mission(s). The bill works by creating a streamlined voluntary application and approval process that determines if the applicant organization meets the standrds for a PRI. A for profit so certified will be on a par with a nonprofit, in the eyes of the IRS, in so far as mission. If the applicant organization is an L 3 C which under its state charter must also agree to operate as per the PRI rules then the use of for profits to perform social missions should exponentially increase. Will facilitate private investment and bring the efforts of entrepreneurs to social problems. For the first time free enterprise and the charitable sector will join for common causes!

2 The key element is the unlocking of private investment in areas that have heretofore been considered the providence of government and nonprofits. While governments at all levels are buried under a sea of debt unprecedented in our history and the nonprofit sector tries to deal with issues way beyond their financial capacity, trillions of dollars in private investment funds are seemingly beyond the reach of those trying to solve our most pressing problems. The comments made by Congressmen Gardner and Polis in their press release of July 25, 2013, regarding the PFA are very significant. Gardner - The Philanthropic Facilitation Act would make it easier for foundations and other philanthropic organizations to contribute financially to job creators across the country. The bill works by streamlining the approval process that determines eligible recipients of charitable investments. Under current law, foundations must make charitable expenditures each year in order to keep their tax status. Gardner s legislation would expedite the current process for Internal Revenue Service (IRS) rulings on whether or not an investment to a low-profit entity would count towards their yearly expenditures. It streamlines the process by directing IRS to respond within a certain time frame, and all foundations wanting to make an investment in the same entity would be able to rely on the IRS determination. Many of our rural areas continue to face declining populations because of dwindling job prospects. This bill will help encourage investment in rural communities by cutting government red tape and providing new opportunities for businesses, said Gardner. Private organizations are ready and able to invest in critical employers in rural areas, but are too of ten held-up by government approvals. This bill will unleash investment by removing redundant and harmful government roadblocks. Polis - I am proud to partner with Representative Gardner on the Philanthropic Facilitation Act, which will encourage and increase investment in education and renewable energy without any cost to the taxpayers. Simplifying partnerships between nonprofit foundations and for-profit investors, the Philanthropic Facilitation Act will stimulate economic growth and support socially responsible businesses that are committed to charitable work. The press release reflects the interest and focus of the Congressmen and their constituents and in doing so just touches on the scope and impact this bill will have. From the perspective of the social entrepreneur and social enterprises, it may be the most important bill ever written. For the first time it would totally legitimize the role of the social entrepreneur and recognize their importance in the social structure of our country. In addition, many of those who want to attack social problems with a for-profit vehicle are members of the new and rapidly growing class known as social entrepreneurs. They are forming specialized vehicles like L 3 Cs directed towards using for-profits

3 to further social change. They have the ideas and the drive to solve problems just like ordinary for-profit entrepreneurs and can exhibit the quick reaction to changing conditions that is the hallmark of entrepreneurs. L 3 Cs and other social enterprises organized under the LLC laws have the advantage of being able to bring together disparate groups such as foundations, individual investors, private equity funds, government agencies, Donor Advised Funds (DAFs), and others each with unique contributions and expectations of returns, L 3 Cs under their state charters bring the added advantage of branding and statutory requirements that insure investment dollars will be used for charitable purposes. Once a social enterprise makes voluntary application and receives IRS certification under the PFA, it will, like a nonprofit, be free to approach private foundations and others for investment as per their status and willingness to invest. What is a Program Related Investment (PRI)? One common misconception about philanthropy is the belief that private foundations must distribute money only to 501(c)(3) charitable organizations in order to meet their annual distribution requirements, but this is not the case. Foundations can meet the requirement in several ways as long as a charitable purpose is furthered. PRIs are one such exception and they date back to the Tax Reform Act of The PRI exception allows a foundation to make an investment in a for-profit entity and have that investment meet the requirements within the meaning of section 170(c)(2)(b) of the Internal Revenue Code of 1986 and not have been formed but for its relationship to the accomplishment of charitable or educational purposes. What does all this really mean? It means that for the first time since the tax laws of 1969 and 1986 clearly defined what a charitable for profit organization had to look like, there will be a way, if the PFA is passed into law, for a for profit performing charitable work to easily be recognized by the IRS just as a nonprofit now achieves 501(c)(3) status. This opens the door for investment dollars as never before. Lets examine the impact on some possible investors. Private foundations have been allowed to make PRIs for years but never had a simple way to determine if the for profit asking for a PRI was qualified. The ensuing complications scared off 95% of all private foundations. PRIs are often structured as loans, but they might also be direct equity investments, loan guarantees, leases, real property, or other investments. PRIs are commonly used to support community revitalization, low-income housing, economic development, and microenterprise creation, as well as historic preservation, human services, and education. But from a structural point of view the foundation role can be pivotal. Private foundations must give away approximately 5% of their asset value each year for charitable purposes, PRIs count in the 5%. Since they are giving the money away there is, from a practical point of view, no such thing as financial risk to a foundation in a grant or a PRI. In making a PRI a private foundation has to show the IRS that its investment follows the profile of a grant - high risk/ low return. If a private foundation makes a PRI to a for profit that qualifies under the PFA it should make a high risk/low return investment. The result turns the venture capital model on its head and can easily improve the creditworthiness of a social enterprise particularly if the enterprise is

4 organized as an L 3 C since the foundation investment can take the first risk (first loss) tranche or layer but at a low cost to the enterprise. Putting in place the PFA approval process for PRIs would greatly cut down on transaction costs associated with making a PRI, thereby facilitating their use and providing greater protections to both the private foundation and the government that the PRI funds are being used properly. The bill does not change the fundamentals of PRIs or how they work, nor does it require PRI makers to solicit IRS approval; its is a voluntary process whose main goal is to increase efficiency so more funds can be directed to public purposes. The bill would also improve transparency because all organizations choosing to register under the PFA would have to file an annual public report outlining their charitable work during the year. For DAFs the PFA will open an entirely new set of opportunities. Individuals who create DAFs are often entrepreneurial types who having made substantial sums of money wish to give back to society. DAFs have become very popular since they are quick and easy to create, have the highest rate of tax deduction and a very low maintenance cost. A DAF could make a PRI type investment into a social enterprise certified under the PFA. The big advantage here is that it puts the commercial investment houses like Fidelity or Wells Fargo in the business of raising investment dollars for social enterprise. Likewise, Community Foundations which are huge in the DAF market will also be able to easily support social enterprise. The IRS certification will also facilitate commercial investment in social enterprise as it will create a type of organization to fund. If this type of organization is also an L 3 C it will carry branding and further structure that will streamline the process of creating classes of commercial investment product that can be sold through financial advisors everywhere. Given the regulatory restrictions of the investment world, the creation and sale of product relevant to the social enterprise sector has always been difficult due to the lack of standardized structures. The PFA will lead to the creation of product such as the SYON (Social Yield Option Note) which will essentially use an L3C structure to finance projects under the Social Impact Bond or Dream Contract concept. (see americansforcommunitydevelopment.org/whitepapers.html ) Impact Investors will for the first time be able to recognize a business which the federal government has classified as having a charitable purpose. This should make it easier for pension funds, endowments, etc. which would like to put a portion of their funds into a social enterprise to do so by investing in a tranche of a social enterprise. The PFA also opens the door for further legislation at the federal, state and local level to give special treatment to specific social enterprises certified under the PFA. An important feature of the PFA is that it creates a voluntary registration process. It is a rarity in federal law which will empower the social flexibility. Any business which wishes to provide some degree of charitable service to society but not declare itself a full fledged charitable enterprise will be free to continue to operate without registration or reporting requirements to the IRS. Even a private foundation will be able, if it so wishes, to make a PRI to a for profit without that for profit being registered, if it so desires, if it is willing to take the compliance risks under existing law. This

5 might be an important feature to a foundation partnering with a large multi - national on a specific charitable activity where the business is not and does not desire to be classified as charitable in its entirety. So the bill adds opportunity and expands options for achieving charitable purposes but retains the flexibility that entrepreneurs prize. It is also a free enterprise bill since in no way does it require private business or investors to make specific investments or engage in specific activities. It merely evens the playing field for investors wishing to make money while doing good. We urge Congress to pass the PFA as a way to redirect trillions of dollars voluntarily to more charitable endeavours, increase domestic jobs, and finance public projects and infrastructure improvements. Copyright 2013 Americans for Community Development americansforcommunitydevelopment.org Americans for Community Development LLC P.O. Box 236, Granite Springs, NY / info@americansforcommunitydevelopment.org