May a nonprofit that makes loans to private individuals and businesses qualify as a Section 501(c)(3) organization? Or is making a loan a “business,” not suitable for public charity status? In the world of microfinance—making small loans to those who lack ready access to funds— the IRS allows for such public charity qualification, albeit within restrictive parameters. Charitable microfinance activities are well grounded in historical practice, they can provide significant societal benefits to disadvantaged communities, and thus they can fulfill tax requirements for “charity."
As set forth in IRS Rev. Ruling 74-587, 1974-2 C.B. 162, a micro-loan program may fit within Section 501(c)(3) parameters if it meets certain conditions: “an organization formed to relieve poverty, eliminate prejudice, reduce neighborhood tensions and combat community deterioration through a program of financial assistance in the form of low-cost or long term loans to, or the purchase of equity interest in various business enterprises in economically depressed areas, is exempt under Section 501(c)(3) of the Code.” In that IRS Ruling, financial assistance was provided to corporations or individual proprietors who were not able to obtain funds from conventional commercial sources because the poor financial risks involved. The program’s purpose was to enable the recipients of funds to start a new business or to acquire or improve an existing business. As such, it qualified as tax-exempt charitable activity.
A Case Study: Hope International
Today, many nonprofit organizations conduct micro-financing activities as part of furthering specific charitable purposes under Section 501(c)(3), both in the US and overseas. One such organization, Hope International (“Hope”), recently held an “Investing in Dreams” event in the Chicago area, showcasing its tax-exempt microfinance program. Hope International exemplifies an organization which combines micro-financing tools with a mission of training, Christian discipleship and empowerment.
According to Hope’s Vice-President of Development Chris Horst, microfinance is not always revolutionary, but done right, it is almost always helpful. While the news has cycled through both critical and idealized coverage of the impact of microfinance, on the whole, the findings are quite encouraging. As Hope views it, microfinance provides one of the key instruments in the fight against poverty. There is clearly a compelling case for why this instrument of microfinance is an extraordinarily helpful tool to alleviate poverty.
Horst gives four reasons, as excerpted from his presentations at Acton University and the American Enterprise Institute in June 2016. We found Horst’s explanation particularly useful for both understanding why microfinancing constitutes a charitable, educational, and even religious activity under 501(c)(3) and for justifying the public need, benefit, and impact for such programming.
1 – Microfinance brings people into the formal financial sector
One can imagine how difficult life would be if there were no place to safely save or borrow money. If the only place to save was a lockbox in one’s home, or the only place to get a mortgage was from a neighborhood moneylender or a family member. This is normal life for half of the world’s population, who live outside the formal financial sector. Microfinance allows them to have the reliability, security, and consistency of an actual bank account.
2 – Microfinance helps people materially
Over the past decade, dozens of random controlled trials have been conducted about the impact of microfinance. The studies have shown improvement in self-employment business activities and in household consumption. In one of these studies in Morocco, access to small loans enabled the people who accessed these loans to increase business profit, increase business investments, increase business assets, and increase business revenue. But the studies also found that savings products have had the greatest material impact on the lives of people outside the financial sector. In Kenya, researchers found that access to reliable savings enabled savers “to mitigate the risks of health shocks and increase investments in their businesses by 38-56%.”
3 – Microfinance helps communities socially
Healthy communities depend on a vibrant civil society. Civil society exists when people come together linked by common interests and shared activities. Microfinance, at its very core, builds up the civil society of communities where it exists, bringing people together in meaningful ways to grow with one another.
In Rwanda, one Hope savings group came together with a unique shared experience: All the members of the group were blind. This group named their savings group “Twi-sun-gan-ee” which means “Let us lean on one another.” And they have. Each week, they meet and go through a biblically-based training, then they become a bank for one another, saving and lending to help meet each other’s financial needs. The group began with each member saving just $.13/week. They have begun to both experience joy in their relationships with each other, but also with their worth and purpose. Today, the group has $80 in a shared savings account and $180 in loans outstanding to members of the group. The president of the group, Alphonse, has launched a small manufacturing business with the members of the group. Together, they make baskets, mats, and soccer balls to sell in their community. The group has begun reaching out to other disabled people in their communities, encouraging them to start groups of their own. Microfinance can help communities reconnect socially.
4 – Finally, microfinance has an impressive historical record
People serving the world through microfinance is not a new idea. In fact, its practice has been one practiced throughout history. In the 1500s, religious nonprofits enabled men and women living in poverty to borrow and save with one another. They provided low-interest loans to poor peasant families, ensuring there was enough food on the table. Started by the Franciscan monks, these banks became widespread throughout Europe and became the lifeblood of poor European peasants.
In the late 1700s, Hannah More played a significant role among the disadvantaged communities where she served. She was a member of the influential Clapham group that famously helped to stop the British slave trade. More helped to establish banking cooperatives among women who were excluded from the banks, allowing them to save small amounts of money safely with a larger group. Then, if one of the members of the club lost her job or contracted an illness, she received a payment from the group to help her cope with that situation.
In the United States, the first savings bank to be incorporated was The Provident Institution for Savings in 1816. Responding to a challenge from Catholic priest Cheverus, several prominent Boston philanthropists unanimously approved the creation of a “benevolent institution” with the mission to “simply to provide a place where the poor may deposit their small savings, and be allowed to receive interest, with liberty also to withdraw the whole or any part of their deposit whenever they may desire it.” This nonprofit bank returned all profits to grow the bank or as a dividend directly to the depositors. The founders of Provident Institution for Savings understood that microfinance only works if both the institution and the saver benefit.
Considering it All
Horst’s four reasons provide a compelling picture of a nonprofit that uses microfinance to advance tax-exempt charitable purposes – mission-driven, mission-focused, and tangibly helping disadvantaged populations. Through such a thoroughly mission-driven and mission-minded commitment focusing on financing for disadvantaged communities, such microfinance activity stays squarely within the requisite Section 501(c)(3) tax-exempt parameters.