IRS: “Impact Investment Advising is not a Charitable Activity”

In October 2020, the IRS released a private letter ruling (PLR 202041009) in which the IRS denied tax-exempt status to a nonprofit formed for the purpose of increasing social welfare, where the primary program activity consisted of serving as an investment advisor for impact-oriented investors and investment opportunities.

In the ruling, the nonprofit took the positions that their activities facilitated the deployment of assets toward investments that improve societal welfare and that providing these investment advisement services at a lower-than-market cost. However, the IRS remained unconvinced, and (citing numerous rulings and court cases spanning decades) ruled that the primary investment advising activities were non-charitable. (The IRS also ruled that any charitable activities were insufficiently incidental to the non-charitable advising activities.)

For legal advisors in this space, this ruling is troubling, though not entirely surprising. However, the IRS raises many interesting points in the ruling, largely because the IRS doesn’t clearly rely on any singular basis for denying exemption, but instead invokes a long list of bases for its ruling:

• The advisor was subject to state investment advisor laws that could require seeking higher returns over pursuit of charitable purposes;
• The advisor offered its services to all customers, without limiting to 501(c)(3) clients;
• The advisor prioritized a risk/return screen for potential investments over any charitable screen;
• The advisor did not intend to seek charitable contributions; and
• The advisor charged below-market fees, resulting in higher potential returns to investors.

The IRS does not point to any particular fact or circumstance that would, on its own, preclude exemption. Instead, the IRS appears to aggregate all of these facts and circumstance together in arriving at an overall conclusion that the investment advisement services are not charitable. As a private letter ruling, this decision is not directly applicable to other organizations or binding on the IRS, but does provide some indication of how the IRS views impact investing activities in the context of the tax-exempt organization rules.

For advisors, this list is a helpful set of data points for identifying red flags that can arise in housing impact investment activities in a tax-exempt organization. And, the IRS does appear to leave open some possibilities for conducting some impact investment activities within a tax-exempt organization, for example, if performed in close connection with separate charitable programs.