It certainly has been busy lately in the tax world, with the passage of the tax bill, and we will be posting regular analysis and updates on that legislation in the weeks to come. However, it’s important not to lose sight of other important developments—tax practitioners have been waiting quite some time for follow-up guidance on donor advised funds, and the IRS has answered that call with Notice 2017-73, which discusses the future issuance of proposed regulations on a variety of matters related to donor advised funds (“DAFs”). We will cover the notice in a series of blog posts, beginning with this one on the appropriate tax treatment of purchases of tickets to attend charity events and fulfillment of pledges of donor/advisors. Our second post will discuss potential limits on the ability to use grants from a DAF to meet support tests for public charities. Finally, a third post will discuss other key DAF issues on which the IRS is seeking comments.
Greater Than Incidental Benefit
Section 4967 of the Tax Code imposes an excise tax on any distribution from a DAF that results in a donor, advisor, or certain related parties (a “donor/advisor” for simplicity) from receiving, either directly or indirectly, more than an incidental benefit. In other words, persons who are insiders are not allowed to use their influence over a DAF to make distributions that benefit themselves more than incidentally. The excise tax is imposed on any person that advises the DAF regarding the distribution or on the person who receives the prohibited benefit. A separate excise tax is imposed on a DAF manager that agrees to make such a distribution knowing that it is conferring a prohibited benefit on a donor/advisor.
Tickets to Events and Memberships. Several commentators have asked for clarification of the rule with respect to what amounts to more than an “incidental” benefit. Specifically, commentators have asked about when a DAF purchases memberships or tickets to charity-sponsored events that enables donor/advisors to attend or participate in the event. Typically, the cost of memberships or tickets to attend charity events include both a fair market value component (e.g., the value of the meal provided, or of the services received under the membership) and a charitable component—and individual purchasers are entitled to deduct as a charitable contribution the amount that the cost of the ticket exceeds the value of goods or services provides. So if a charity charges $1,000 for a ticket to an event and the fair market value of the dinner is $100, the purchaser is entitled to deduct $900 of the cost of the ticket as a charitable donation.
Some commentators have argued that DAFs should have similar treatment to individuals for these purposes. For instance, if the donor/advisor personally pays the $100 portion of the ticket to cover the value of their dinner, it should not be a problem for the DAF to cover the charitable component. However, Notice 2017-73 makes clear that the IRS does not agree with this argument, and instead views the donor/advisor as being relieved of a financial obligation to pay the additional $900 to the charity in order to attend the event. In other words, if a DAF pays any portion of an event ticket or membership where a donor/advisor gets a benefit, there is an impermissible private benefit. This is consistent with long-standing IRS treatment of these transactions under the private foundation self-dealing rules.
Payment of Pledges. Similarly, there has been some uncertainty as to whether a donor/advisor can advise a DAF to make a distribution to satisfy a personal pledge, or whether this results in a greater than incidental benefit. The notice acknowledges arguments that the propriety of allowing satisfaction of pledge can hinge on whether the pledge is legally binding under state law—a question that often turns on factual details that are difficult for a sponsorship organization to ascertain.
As such, the notice indicates that the IRS is considering clarifying that distributions from a DAF to a charity will not result in greater than incidental benefit merely because the donor/advisor has made a pledge to that charity (regardless of whether the charity treats the distribution as satisfying that pledge), if the following requirements are satisfied:
- the sponsoring organization makes no reference to the existence of a charitable pledge when making the DAF distribution;
- no donor/advisor receives, directly or indirectly, any other benefit that is more than incidental on account of the DAF distribution; and
- a donor/advisor does not attempt to claim a charitable contribution deduction with respect to the DAF distribution, even if the charity erroneously sends the donor/advisor a written acknowledgment with respect to the DAF distribution.
Notice 2017-73 is clear that this treatment regarding pledges will not extend to private foundations—there is enough of a difference between the organizations to warrant the differing treatment.