Yes, a nonprofit can have an investment account, and most organizations open one as soon as reserves grow beyond what daily operations require. The Uniform Prudent Management of Institutional Funds Act, adopted in nearly every state, authorizes charities to invest in a broad range of assets, and tax-exempt status under Internal Revenue Code Section 501(c)(3) generally shields the resulting investment income from federal tax. Two situations complicate that clean picture: investments bought with borrowed money, and any organization classified as a private foundation.
Types of Accounts a Nonprofit Can Open
Nonprofits have access to essentially the same investment vehicles as any institutional investor. The right mix depends on the organization’s size, liquidity needs, and time horizon.
- Brokerage accounts are the most flexible option, allowing the organization to buy and sell stocks, bonds, mutual funds, and exchange-traded funds. This is the standard choice for building a diversified portfolio.
- Money market accounts and certificates of deposit are lower-risk options for reserves the organization may need within the next one to three years. Returns are modest but principal is relatively safe.
- Endowment funds are a legal structure rather than a specific account type. Donor-restricted endowments hold gifts where the donor specified that principal must remain intact, with only investment returns available for spending. Board-designated endowments function similarly, but the board retains authority to access the principal if circumstances require it, since no donor restriction limits spending.
- Program-related investments advance the nonprofit’s charitable mission rather than generate financial returns. A housing nonprofit making below-market loans to low-income borrowers is a classic example. These qualify for special tax treatment if the primary purpose is charitable, there is no significant purpose of producing income, and the investment does not fund political lobbying or campaigns.1Internal Revenue Service. IRC Section 4944(c) – Taxes on Investments Which Jeopardize Charitable Purpose – Exception for Program-Related Investments
What You Need to Open the Account
The documentation is heavier than for a personal account, and the first attempt trips up a surprising number of organizations. Before contacting a brokerage, gather the organization’s IRS determination letter confirming 501(c)(3) status, the Employer Identification Number, articles of incorporation, and current bylaws. Most custodians also require a board resolution specifically authorizing the account and naming the individuals permitted to direct transactions.
Choosing a custodian matters. Some brokerages have dedicated nonprofit or institutional desks with lower minimums and fee structures designed for tax-exempt organizations. Others treat nonprofits like any retail client and charge accordingly. Advisory fees for professionally managed nonprofit portfolios typically run around 1 percent of assets under management, and larger portfolios can negotiate lower rates. Treat the selection with the same care the board applies to any major vendor relationship.
How the Board Must Manage Invested Funds
The primary law governing how charities manage invested funds is the Uniform Prudent Management of Institutional Funds Act, commonly called UPMIFA.2Uniform Law Commission. Prudent Management of Institutional Funds Act – Uniform Law It applies to both donor-restricted endowment funds and funds the organization holds for its own use. Under UPMIFA, boards can pursue a total-return investment strategy, meaning both income (dividends, interest) and long-term capital appreciation count when making investment decisions.
Board members who oversee investment accounts carry real personal exposure if they neglect their responsibilities. UPMIFA and state nonprofit corporation laws require directors to manage invested funds in good faith, with the care that a reasonably cautious person in a similar position would exercise. The standard applies to the portfolio as a whole, not individual investments. A single stock that drops 40 percent is not automatically a breach if the overall portfolio was properly diversified.
The specific duties fall into three obligations. The duty of care requires directors to stay informed about the organization’s financial health and investment performance throughout the year, not just at annual meetings. The duty of loyalty requires that investment decisions serve the organization’s mission, not any director’s personal financial interests. The duty of obedience requires that investments comply with the organization’s governing documents, any donor restrictions, and applicable law. Failure to meet these standards can lead to personal liability, removal from the board, or both.
Hiring an Outside Manager
Most nonprofit boards lack the expertise to manage a portfolio themselves, and UPMIFA explicitly permits hiring an outside investment manager. Boards often breathe a sigh of relief at this point and then make their biggest governance mistake: assuming delegation means the board is off the hook.
UPMIFA requires the board to exercise care in three areas when delegating. The board must carefully select the manager, establish the scope and terms of the manager’s authority in writing, and periodically review the manager’s performance. Quarterly or semiannual reviews are the norm. During those reviews, the board should assess whether the manager is following the investment policy, executing trades within the authorized asset allocation, and complying with any donor restrictions.
The Investment Policy Statement
An investment policy statement translates the board’s intentions into actionable guidelines for whoever manages the money. Every nonprofit with an investment account should have one, and many custodians will ask for it during account opening.
At minimum, the policy statement should address the organization’s risk tolerance, liquidity requirements (how much cash needs to be accessible within 30, 60, or 90 days), time horizons for different pools of money, and target asset allocation across equities, fixed income, and cash equivalents. It should also specify any restrictions, such as prohibitions on investing in industries that conflict with the organization’s mission. The board should formally approve the policy during a recorded meeting, note it in the minutes, and revisit it at least annually.
How Investment Income Is Taxed
For most public charities, the tax treatment of investment income is straightforward: it is not taxed. An organization that qualifies for tax exemption under Section 501(c)(3) is generally exempt from federal income tax on dividends, interest, capital gains, and other passive investment returns.3Office of the Law Revision Counsel. 26 USC 501 – Exemption From Tax on Corporations, Certain Trusts, Etc. The Internal Revenue Code specifically excludes from unrelated business taxable income all dividends, interest, annuities, royalties, and most rents, along with gains from the sale of investment property.4Office of the Law Revision Counsel. 26 U.S. Code 512 – Unrelated Business Taxable Income
A public charity can sell appreciated stock, collect bond interest, and receive mutual fund distributions without owing federal income tax on any of it. That is a strong argument for investing reserves rather than letting them sit in a low-yield checking account.
When Investment Income Becomes Taxable
The major exception involves unrelated business income tax, or UBIT. When a tax-exempt organization earns income from a trade or business that is regularly carried on and not substantially related to its exempt purpose, that income is taxed at regular corporate rates.5Office of the Law Revision Counsel. 26 USC 511 – Imposition of Tax on Unrelated Business Income of Charitable, Etc., Organizations Passive investment income like dividends and capital gains is excluded, but debt-financed investments pull returns back into taxable territory.
If a nonprofit borrows money to purchase an investment, the income from that investment becomes partially taxable. The taxable percentage is calculated by comparing the average outstanding debt on the property to the property’s average adjusted basis during the year.6Office of the Law Revision Counsel. 26 U.S. Code 514 – Unrelated Debt-Financed Income If a nonprofit takes out a loan to buy a rental property and finances 60 percent of the purchase, roughly 60 percent of the rental income could be treated as unrelated business taxable income. This is the single most common way nonprofits accidentally generate a tax bill from their investment accounts, particularly organizations that invest in leveraged real estate or buy securities on margin.
Any tax-exempt organization with $1,000 or more in gross income from an unrelated business must file IRS Form 990-T.7Internal Revenue Service. Unrelated Business Income Tax The threshold is low enough that even modest debt-financed income can trigger a filing obligation. Review holdings annually to identify any debt-financed positions and budget for the tax before it becomes a surprise at filing time.
Extra Rules for Private Foundations
Private foundations face a substantially harsher regulatory landscape than public charities. If your organization is classified as a private foundation, the following rules apply in addition to everything above.
Excise Tax on Net Investment Income
Private foundations pay a flat 1.39 percent excise tax on net investment income every year.8Office of the Law Revision Counsel. 26 U.S. Code 4940 – Excise Tax Based on Investment Income Net investment income includes dividends, interest, rents, royalties, and capital gains from selling investment assets, minus attributable expenses.9Internal Revenue Service. Tax on Net Investment Income – Capital Gains and Losses A foundation that expects to owe $500 or more must make quarterly estimated tax payments, with the first payment generally due by May 15 of the tax year.
Unlike public charities, which can sell appreciated investments tax-free, private foundations must include all capital gains in the net investment income calculation. That includes gains from assets used to further the foundation’s exempt purpose, not just assets held purely for investment. Capital losses can offset capital gains from the same tax year, but excess losses cannot be carried forward or backward and cannot reduce other types of investment income.9Internal Revenue Service. Tax on Net Investment Income – Capital Gains and Losses
Self-Dealing
Private foundations face strict rules against financial transactions between the foundation and its “disqualified persons,” a category that includes substantial contributors, foundation managers, and their family members. Prohibited transactions include buying or selling property between the foundation and a disqualified person, lending money in either direction, and transferring foundation income or assets for the benefit of a disqualified person.10Office of the Law Revision Counsel. 26 U.S. Code 4941 – Taxes on Self-Dealing
The penalties are severe. The disqualified person who participates in a self-dealing transaction owes an initial excise tax of 10 percent of the amount involved for each year the transaction remains uncorrected. A foundation manager who knowingly participates owes 5 percent. If the transaction is not corrected within the taxable period, the additional tax jumps to 200 percent of the amount involved for the self-dealer and 50 percent for the manager.10Office of the Law Revision Counsel. 26 U.S. Code 4941 – Taxes on Self-Dealing A foundation board member cannot direct foundation investments into a fund managed by a family member or purchase property from a major donor, regardless of how fair the price might be.
Jeopardy Investments
The IRS can impose excise taxes on private foundation investments that jeopardize the foundation’s ability to carry out its charitable purpose. The standard is whether foundation managers failed to exercise ordinary business care and prudence in providing for the foundation’s long-term and short-term financial needs.11eCFR. Subpart E – Taxes on Investments Which Jeopardize Charitable Purpose No category of investment is automatically a violation, but the IRS closely scrutinizes trading on margin, commodity futures, puts and calls, warrants, and short selling.
A jeopardy investment triggers an initial excise tax of 10 percent of the amount involved on both the foundation and any manager who knowingly participated. If not removed from jeopardy within the correction period, the foundation faces an additional 25 percent tax and the manager another 10 percent.12Internal Revenue Service. Taxes on Jeopardizing Investments The determination is made based on circumstances at the time of the investment, not with hindsight, so a well-documented decision-making process matters if the IRS later questions a position.
Excess Business Holdings
Private foundations and their disqualified persons are limited in how much of a business enterprise they can own combined. The general rule caps combined ownership at 20 percent of the voting stock of an incorporated business. If unrelated third parties maintain effective control of the business, the cap rises to 35 percent. Holdings that exceed these limits trigger an initial excise tax of 10 percent of the value of the excess. If the foundation fails to divest within the correction period, the additional tax is 200 percent of the remaining excess.13Office of the Law Revision Counsel. 26 U.S. Code 4943 – Taxes on Excess Business Holdings Foundations that receive large stock gifts from donors sometimes run into this rule unexpectedly, so boards should monitor ownership percentages whenever new contributions arrive.