philanthropic facilitation act proposal

8/6/2019 Philanthropic Facilitation Act Proposal

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Proposal for Philanthropic Facilitation Act

The problems are many and the

dollars available for solutions are

few. We need to maximize the

returns from the use of nonprot

dollars and reduce the transactional

costs while insuring compliance with

the law and not creating new costs

for government.

The transactional costs of complex excise taxes and

burdensome paperwork for PRIs (Program Related

Investments) result in decreased dollars brought to bear on

the important issues of the day.

Basic Explanation - November 9, 2010

Why Support the Philanthropic Facilitation Act

This proposal outlines the benets of passage of the proposed act which is

truly bipartisan and structured to help the charitable activities of all nonprots

and L3Cs.*

The proposal was written for us by Elizabeth Carrott Minnigh of Buchanan

Ingersoll & Rooney (202-452-6048) [email protected]. Please feel

free to contact her with any legal questions.

Some of the material contained herein was taken from a previous proposal by

the Council on Foundations which supports this legislation. Please feel free to

contact Andrew Schultz of COF (703-879-0715) [email protected] with questionrelevant to COFs position.

For all other questions please contact Robert Lang of Americans

for Community Development (914-248-8443) robert.lang@

americansforcommunitydevelopment.org.

We look forward to your support.

*Low-prot Limited Liability Company - It is a for prot venture that under its state charter must have a

primary goal of performing a socially benecial purpose not maximizing income. For More Information

Regarding the L3C Visit Our Website:americansforcommunitydevelopment.org

P.O. Box 236 Granite Springs, NY 10527 914.248.8443

americansforcommunitydevelopment.org


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PROPOSAL FOR PHILANTHROPIC FACILITATION ACTProposal Summary: The current economic recession has resulted in the coincidence of fewer philanthropic dollars with greater philanthropic need. Accordingly, private foundations arelooking for a way to protect their endowments and, where appropriate, generate a return,

however modest, on their funds available for distribution.1

Section 4940 of the Internal RevenueCode of 1986, as amended (the "Code"), imposes a two-tiered tax on net investment income,which creates an impediment to increased giving. The proposed Philanthropic Facilitation Actwould simplify the excise tax on net investment income under Section 4940 of the Code, byeliminating the two-tiered rate and replacing it with a single, flat revenue-neutral rate of 1.4%2and, thereby, encourage foundations to maximize annual distributions. The exception for program-related investments under Section 4944 of the Code, allows a non-profit to make areturn on an investment that also qualifies as a qualifying distribution under Section 4942 of theCode. The proposed Philanthropic Facilitation Act would improve the ability of privatefoundations to use the program-related investments exception more efficiently, by streamliningthe approval process, and thereby open up additional capital for investment in economically-

distressed industries, creating jobs and improving economic conditions in local communities.3

I. OVERVIEW OF TAX ON NET INVESTMENT INCOME:THE DISINCENTIVE FORINCREASED

DISTRIBUTIONS FROM PRIVATE FOUNDATIONS

Section 4940 of the Code requires private foundations to pay an annual excise tax equalto 2% of their net investment income. In any year in which a foundation's distributions(measured as a percentage of assets) exceed the average payout rate of the foundation calculatedover the preceding five years by at least 1%, this excise tax is reduced to 1%.

The requirement under Section 4940(e) of the Code that a foundation's distributionsexceed the average payout rate of the foundation calculated over the preceding five

years by at least 1% was intended to ensure that the tax savings afforded to thefoundation be used for additional charitable expenditures and not merely added to theendowment of the foundation.4

Regardless of whether a foundation qualifies for the 1% reduction under Section 4940of the Code, the foundation is still required under Section 4942 of the Code to makeannual minimum distributions equal to approximately 5% of the foundation's assets.

1 Shelly Banjo, Consider It an Investment, WALL ST.J., Nov. 9, 2009, available athttp://online.wsj.com.2 The Staff Joint Committee on Taxation analyzed the Section 4940 excise tax in connection with S. 676 / H.R.

4090, 111th Cong. (2009), and indicated that a flat rate of 1.39% would be revenue neutral. Council on Foundations,Simplify the Excise Tax on Private Foundations (S. 676 / H.R.4090) , Oct. 2010, available at

http://www.cof.org/templates/311.cfm?ItemNumber=16095.3 Private foundations give away an estimated $40 billion annually. See Pablo Eisenberg , What's Wrong With

Charitable Givingand How to Fix It, WALL ST.J., Nov. 9, 2009, available athttp://online.wsj.com.4 STAFF OF JOINT COMM. ON TAX.,98th Cong. 2d, Gen. Explanation of H.R. 4170, at 672-3 (Dec. 31, 1984)


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PROPOSAL FORPHILANTHROPIC FACILITATION ACT PAGE 3

Although the favorable tax treatment of, and potential investment return, on PRIsshould make them attractive to private foundations, a survey of more than 75,000private foundations showed that in 2006 those private foundations collectively madequalifying distributions in the aggregate amount of $39.0 billion; on an endowment base of $614.7 billion and in 2007 those private foundations collectively made

qualifying distributions in the aggregate amount of $44.4 billion; on an endowmentbase of $682.2 billion;6

however, over that same two year period, PRIs accounted forless than 1% of these qualifying distributions, despite being a strong tool to advancetheir charitable purposes.7

Currently, there is no process to confirm that a private foundation's proposed PRIinvestments will comply, both initially and over time, with the PRI regulationsunder Reg. 53.4944-3(a). Additionally, there is no uniform standard for formingentities to serve as recipients of PRIs.

Traditionally, many private foundations have refrained from investing in for- profit ventures due to the uncertainty of whether a specific investment wouldqualify as a PRI or because of the cost, time and resources to acquire a privateletter ruling from the IRS to verify that the particular venture is a valid PRI8 or alegal opinion from counsel.

Implementing an application process that would permit registration of theproposed recipient of a PRI, similar to the process that nonprofits under take insubmitting Form 1023, Application for Recognition of Exemption Under Section501(c)(3) of the Internal Revenue Code, and a reporting requirement for the actualrecipients of PRIs, similar to the Form 990-PF, Return of Private Foundation orSection 4947(a)(1) Nonexempt Charitable Trust Treated as a Private Foundation,would cut down on the transaction costs associated with making a PRI, thereby

facilitating their use and providing greater protections to both the privatefoundation and the government that the PRI funds are being used properly.

Without clarification of the rules surrounding PRIs, the philanthropic community may continueto be unwilling to undertake PRIs, and, thereby, continue to diminish the resources available for philanthropy at a faster than necessary rate, while at the same time endowments in privatefoundations will likely increase significantly over the near term, due to the current income andestate tax structure.

III. UTILIZING THE PRI EXEMPTION : THE LOW-PROFIT , LIMITED LIABILITYCOMPANY

6 The Foundation Center, Foundation Growth and Giving Estimates: Current Outlook(2009 Ed.), available athttp://foundationcenter.org/gainknowledge/research/pdf/fgge09.pdf.7 The Foundation Center, Doing Good with Foundation Assets, excerpted from THE PRI DIRECTORY (3d Ed.),

available athttp://foundationcenter.org/gainknowledge/research/pdf/pri_directory_excerpt.pdf.8 The current user fee for a private letter ruling for exempt organizations is $ $10,000. Rev. Proc. 2010-8, 2010-1I.R.B., 6.06.


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The low-profit, limited liability company (L3C) format evolved from a desire to relieveeconomic distress caused by high unemployment occurring in areas such as the automobilemanufacturing (see industry summary attached as Exhibit A hereto) and news dissemination (seeProposal for Community News Facilitation Act attached as Exhibit B hereto). However, L3Cs arenot limited to the foregoing industries; rather proposed L3Cs also include food banks, health

clinics, affordable housing, museums and many other entities with a charitable purpose.

The L3C is a new form of LLC formed specifically to further one or more religious,charitable, scientific, literary or educational purposes within the meaning of Section170(c)(2)(B) of the Code (an "exempt purpose").

Although the entity is expected to be a profitable entity, profit-making is asecondary and insubstantial part of its mission.

While the primary purpose of the L3C itself must be an exempt purposes, there isnot requirement that each activity undertaken must be an exempt activity.9 Forexample, an L3C may be structured to undertake a specific activity to produce

sufficient revenue so as to pay the costs associated with achieving its overallexempt purpose.

Pursuant to state statutes, an L3C must be organized and operated at all times in amanner that investments therein satisfy the requirements under Reg. 53.4944-3(a),namely the L3C must possess the following characteristics:

The primary purpose significantly furthers the accomplishment accomplish one ormore of exempt purposes, and the L3C would not have been formed but for itsrelationship to the accomplishment of such purpose(s).

No significant purpose is the production of income or the appreciation of capital;and No purpose is to influence legislation or to "participate in, or intervene in

(including the publishing or distributing of statements), any political campaign onbehalf of (or in opposition to) any candidate for public office."

10

The L3C was first introduced in the United States in April 2008 when Vermontadopted the L3C as an official legal structure. Subsequently, the following jurisdictions have followed suit: Illinois,11 Louisiana,12 Maine,13 Michigan,14 North

9 Public charities and private foundations may undertake a minor amount of activities that are trade and business

unrelated to directly furthering their exempt purposes, although these activities will generate unrelated business

taxable income under Section 512 of the Code. Since the L3C is a fully taxable, the L3C is taxable on all of its

revenue, whether or not it directly furthers an exempt purpose.10 Code 170(c)(2)(D).11 805 ILCS 180/1-5, 805 ILCS 180/1-10, 805 ILCS 180/5-5.12 La. R.S. 12:1301(A)(21), 1302(C), 1305(B)(3), 12:1306(A)(1), 1309(A).13 Me. Rev. Stat. Ch. 21, 1502, 1508, 1559, 1611 (effective as of July 1, 2011).14 Mich. Comp. Laws 450.4102.


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Carolina,15 Utah16 and Wyoming.17 Additionally, the Oglala Sioux Tribe and theCrow Indian Nation of Montana have adopted L3C legislation.

Additionally, North Dakota18 has enacted legislation authorizing feasibilitystudies of the L3C. Similarly, the Arkansas Interim Study Proposal 2009-171 was

adopted this summer.

19

Bills have also been introduced in the state legislatures in the following 11 jurisdictions: Colorado,20 Kentucky,21 Maryland,22 Massachusetts,23 Missouri,24Montana,25 New York,26 North Dakota,27 Oregon28, Tennessee29 and Virginia.30

As a type of LLC, the L3C's flexible structure allows tranched investments bymembers, which have varying levels of risk. If private foundations or public charitiesmake the first loss investments thereby absorbing the highest risk tranche at a verylow return, then the balance of the investments in the L3C will be at a much lower riskand the L3C will be able to attract non-charitable investors, who may earn marketreturns at acceptable levels of risk. Accordingly, the L3C can use the PRI funds to

leverage commercial sources of funds to bring them to bear on social problemstraditionally addressed exclusively by non-governmental organization (NGOs) orgovernment programs. Thus effective use of an L3C can free up charitable andgovernmental dollars to use in other areas.

Because an L3C can tap into both private foundation and for-profit investors, an L3Coffers a more economically sustainable format than a non-profit, alone. Additionally, because anL3C must have an exempt purpose as its primary purpose, the L3Cformat aligns the L3C with thefoundation while expanding the resources available for social enterprise investing within itscommunity.

15 N.C. Gen. Stat. 57C-2-01, 57C-2-21, 55D-20(a).16 Utah Code 48-02c-412 and 48-02c-1411.17 Wyo. Stat. 17-15-102(a)(ix), et seq.18 H.B. 1545.19 H.B. 2102.20 H.B. 10-1111.21 H.B. 371.22 H.B 5 / S.B. 430.23

H 4589.24 H.B. 817.25 H.B. 235.26 A 10414 / S 6726.27 H.B. 1545.28 H.B. 2886.29 S.B. 0472/H.B. 0664.30 H.B. 261.


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IV. NECESSARY AMENDMENTS TO THE INTERNAL REVENUE CODE AND TREASURY

REGULATIONS

In order to implement the foregoing objectives, we respectfully request that Congressmake the following amendments to the Internal Revenue Code of 1986, as amended (the "Code")

and Treasury regulation thereunder:

Amend Section 4940(a) of the Code to strike "2 percent" and insert "1.4 percent." Delete Section 4940(e) of the Code. Amend Section 4944(c) of the Code to clarify that a PRI: (i) is not an investment

which jeopardizes the carrying out of exempt purposes; (ii) qualifies as a qualifyingdistribution under Section 4942 of the Code; and (iii) is not a business holding withinthe meaning of section 4943 of the Code.

Amend Section 4944(c) of the Code to clarify that the primary purpose of the PRI isto accomplish one or more of the purposes described in Section 170(c)(2)(B) of theCode and no significant purpose of the PRI is the production of income or theappreciation of property.

Amend Section 4944(c) of the Code to provide a voluntary procedure for entitieswishing to be the recipients of PRIs to receive a determination by the IRS that aninvestment in said entity qualifies as a PRI, for private foundations with a commonpurpose and, if an investment is deemed to qualify, all private foundations may relyon this determination, unless and until the Secretary publishes a notice of revocationof the determination. The time and cost of said determination should be equivalent tothe average time and cost for the determination of 501(c)(3) tax-exempt status, for a

non-profit.

Add a new section to Chapter 60 of the Code to require information returns for for-profit entities receiving PRIs requiring disclosure of:

Its gross income for the year; Its expenses attributable to such income, incurred within the year; A narrative statement describing the disbursements for and the results obtained

from the use of assets for the exempt purposes of the entity;

A balance sheet showing its assets, liabilities and net worth as of the beginning ofsuch year;

The names and addresses of all private foundations investing PRIs in the for-profit entity.

A statement of the portion of its liabilities and net worth that representcapitalization from PRIs as of the beginning of such year;


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A statement of any interest, dividends or other distributions paid with respect toany PRIs during the year; and

Such other information as the Secretary may by forms or regulations prescribe. Add a new section to Chapter 61 of the Code to require publication of aforementioned

information returns for for-profit entities receiving PRIs.31

Amend Section 7428(a)(1) of the Code to include determinations of whether aninvestment in an entity qualifies as a PRI.

Direct amendments to the Treasury regulations as follows: Amend Reg. Sec. 53.4942(a)-3 to clarify that a PRI qualifies as a qualifying

distribution.

Amend Reg. Sec. 53.4943-3 to exclude a PRI from the definition of a businessholding.

Amend Reg. Sec. 53.4944-3 to reflect all of the changes to Section 4944 of theCode outlined above, including (without limitation) inclusion of:

Examples of the following: (i) an investment in a L3Cthat would qualify as aPRI; (ii) an investment in a L3Cthat would not qualify as a PRI at the outset;and (iii) an investment that initially qualified as a PRI but due to a change incircumstance no longer so qualifies.32

Procedures for a private foundation to divest itself of a PRI that no longer soqualifies, within a specified time period, without incurring excise tax.

Such conforming changes as may be necessary to implement the foregoingprovisions.

362369.10

31 Robert Ottenhoff, CEO of Guidestar, has stated that Guidestar would be willing to include such statements on itsdatabase. Telephone call between Robert Ottenhoff, CEO of Guidestar, and Robert Lang, CEO of Americans for

Community Development LLC.31 The regulations under 4944 were finalized in 1972 and are in great need of updated examples to reflect changes inboth law and practices. In a letter from Stuart M. Lewis, Chair, Section of Taxation, American Bar Association, to

Hon. Douglas Shulman, Commissioner, Internal Revenue Service, dated March 3, 2010, the ABA Section on

Taxation proposed 19 proposed new program related investment examples. A copy of this letter is available at

http://www.abanet.org/tax/pubpolicy/2010/Comments_Concerning_Proposed_Additional_Examples_on_Program_

Related_Investments.pdf.


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Exhibit A

AN INDUSTRY IN NEED:AUTO MANUFACTURERS

Michigan, Ohio, and Indiana combined account for almost half of all jobs in the autoindustry.

33These states, particularly Michigan, have built an infrastructure and an economic base

oriented around that industry for more than a century. However, the auto industry is seeingdecreased demand for its products, increased unemployment amongst autoworkers and excesscapacity at facilities:

The U.S. Bureau of Labor Statistics estimates that the already ailing industry will seea decrease in employment of 16.3% by 2018, compared to an estimated 11% percentgrowth for employment in all industries combined.34 For the past four years,Michigan has held the nation's highest unemployment rate, at approximately 15%.35

Auto sales for U.S. automakers began falling in the spring of 2008 as gas prices rose,and, in October 2008 when the current recession worsened, sales dropped to the

lowest level recorded in 25 years.36

As sales by automakers have declined this hashad ripple effect on suppliers, increasing the economic recession in this region.37

Despite approximately 100,000 workforce reductions since 2006 and closing factoriesnationwide, the automakers have been unable to cut their costs at a rate sufficient tokeep up with the steadily declining market for new vehicles.38 The auto industrycurrently has the capacity to produce approximately 90 million cars and light trucks ayear; however, only approximately 60 million were actually sold worldwide in 2009.39 Accordingly, the worldwide auto industry has a third more capacity than isnecessary to meet worldwide demand.40

Despite the decline of the auto industry, the region still possesses two importantresourcesa large network of skilled laborers and existing manufacturing facilities. Many of thesame people and factories that have made automobiles and automobile components can beadapted to manufacture wind turbines, batteries, electric transport vehicles, unique hydro powersystems, solar energy systems and more. Moreover, with its extensive waterfront exposure thereare numerous possible sites to implement these green energy concepts.

33 Bureau of Labor Statistics, Motor Vehicle and Parts Manufacturing in Career Guide to Industries (2010-2011

Ed.), available athttp://www.bls.gov/oco/cg/cgs012.htm. Other states that account for significant numbers of jobs

in the auto industry include Kentucky, Tennessee, and California. Id.34Id.35 Associated Press, Pelosi, LaHood Laud US Investment, N.Y. Times (Jan. 11, 2010), available athttp://www.ny

times.com/aponline/2010/01/11/business/AP-US-Auto-Show-Lawmakers.html.36 Times Topics,Automotive Industry Crisis, N.Y. Times (updated Jan. 12, 2010), available athttp://topics.nytimes.

com/top/reference/timestopics/subjects/c/credit_crisis/auto_industry/index.html.37Id.38Id.39 Marketplace, Automakers Need to Face New Reality (NPR broadcast on Jan. 13, 2010), transcript available at

http://marketplace.publicradio.org/display/web/2010/01/13/pm-reich-commentary/.40Id.


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However, due to the crippling economic recession in this region there is currently notsufficient capital available to purchase and retool the facilities and retrain workers. Thesubstantial start-up costs and period of irregular income at the start of operations makes suchretooling too risky for many for-profit investors. By utilizing the L3Cformat to access privatefoundation support, whether from large national foundations or small community foundations,

the credit rating of the ventures can be substantially improved and attract greater interest fromprivate investors. Additionally, once the facilities have been retooled and workers have begun tocreate the components necessary for green energy sources, new L3CS can be formed to set up andoperate cites to implement these green energy businesses. As a result of these transactions,automakers and suppliers of auto parts would sell off their excess capacity and, thereby, resizetheir businesses to meet consumer demand and improve their balance sheets without additionalgovernmental resources. Additionally, unemployed skilled workers would be reemployed in agrowth industry, which will stimulate the economies in these regions. However, as noted above,the PRI rules must be clarified before a substantial number of entities will be willing to invest inL3CS.

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