Can a Nonprofit Organization Invest in Stocks?

Nonprofit organizations often seek financial sustainability to support their charitable missions. This article explores whether nonprofits can invest in stocks, covering the legal and regulatory landscape, the importance of an investment policy, and tax implications of investment income.

Permissibility of Stock Investments

Nonprofit organizations are generally permitted to invest in stocks and other financial instruments to support their long-term goals and charitable missions. This allows them to grow assets beyond direct donations and grants, providing a more stable financial foundation. Investments can help build reserve funds or generate additional revenue for programs.

This permission comes with significant responsibilities and oversight. Nonprofits must manage assets prudently, aligning investment activities with their charitable purpose. They can open investment accounts to hold stocks, bonds, and mutual funds, growing financial capacity and weathering economic fluctuations.

Investments must not excessively benefit private individuals, such as employees or board members. For example, a nonprofit should not purchase stock in a board member’s company to increase their personal earnings. Avoiding conflicts of interest is paramount; third parties are often engaged to manage funds, ensuring impartiality and adherence to fiduciary duties.

Legal and Regulatory Framework

The legal and regulatory environment for nonprofit investments is primarily shaped by state law, with the Uniform Prudent Management of Institutional Funds Act (UPMIFA) serving as a guiding framework. UPMIFA, a model act, provides guidance on managing and investing charitable funds and endowment expenditures. Most states have adopted a version of UPMIFA, or their own adapted versions, such as New York’s NYPMIFA.

UPMIFA’s core principle is the “prudent person” standard, requiring fund managers to act in good faith and with the care an ordinarily prudent person would exercise. This includes considering the institution’s charitable purpose, economic conditions, and the effects of inflation and deflation. UPMIFA encourages diversified investments that seek both growth and income, focusing on preserving the principal’s purchasing power long-term.

The act provides flexibility for boards to manage funds efficiently while upholding prudent management. It also outlines rules for spending from endowment funds and modifying donor restrictions. Nonprofits must comply with the specific version of UPMIFA enacted in their state of incorporation, as variations exist. The Internal Revenue Service (IRS) also sets broad guidelines for tax-exempt organizations, ensuring investment activities do not jeopardize their tax-exempt status.

Developing an Investment Policy

Establishing a formal Investment Policy Statement (IPS) is crucial for any nonprofit engaging in investment activities. An IPS serves as a written blueprint, outlining the organization’s investment goals, risk tolerance, time horizon, and liquidity needs. It provides clear guidance for the board of directors, investment committee, and external investment managers, ensuring consistent portfolio management.

A comprehensive IPS should detail several elements. It defines the policy’s purpose and scope, and states investment objectives such as capital preservation, income generation, or long-term growth. The document also specifies the organization’s risk tolerance and asset allocation guidelines, outlining the permissible range for different asset classes like stocks, bonds, and cash equivalents.

The IPS also addresses the spending policy for funds, liquidity requirements, and procedures for selecting and monitoring investment managers. It defines the responsibilities of all parties involved, from the board of trustees to external advisors, ensuring clear accountability. The IPS can incorporate specific guidelines, such as socially responsible investing, and outline procedures for regular review and updates to align with changing market conditions or organizational needs.

Tax Considerations for Investment Income

For most nonprofit organizations, particularly those with 501(c)(3) status, passive investment income like dividends, interest, and capital gains from stocks is generally exempt from federal income tax. This exemption applies as long as the income is not derived from an unrelated trade or business, enhancing a nonprofit’s overall return potential.

However, certain scenarios can trigger Unrelated Business Income Tax (UBIT) on investment income. Income generated from debt-financed property is typically taxable. If a nonprofit uses borrowed funds to acquire income-producing property, including stocks, a portion of the income or gain related to that debt may be subject to UBIT. For example, if a property is 75% financed by debt, 75% of the income or gains would likely be taxable.

UBIT might also apply if investment activities constitute an “active trading business” rather than passive investment. While passive income is generally exempt, extensive, regular, and continuous trading could be viewed as an unrelated business. Nonprofits are required to report their investment income to the IRS on Form 990. This form details various types of investment income, ensuring transparency and compliance with tax regulations.