President Biden has proposed in his fiscal year 2023 budget to clamp down on the ability of private foundations to count donor-advised fund distributions toward their mandatory payout amount. Similar proposals have been floated recently, on the basis that closing this “loophole” would get more funds to operating charities more quickly.
Background on Payout Amount. Under Section 501(c)(3), there are two main types of organizations: private foundations and public charities. Private foundations are typically funded by a more narrow base (often a family or corporation), and as such are thought to be less accountable to the public. They are subject to additional regulations on top of the requirements for maintaining 501(c)(3) status generally.
One such private foundation requirement is the mandatory payout, which requires private foundations to make qualifying distributions of at least 5 percent of assets. Qualifying distributions most often take the form of grants to public charities, which conduct charitable, educational or other similar programs and activities. A grant to another private foundation is less common, and would have to meet certain timing requirements around re-distribution to count as a qualifying distribution—in other words, it cannot sit in the grantee private foundation indefinitely.
However, a private foundation currently can make a grant to a donor-advised fund at a public charity sponsoring organization and count that toward its mandatory payout amount—with no timing requirements around the donor-advised fund re-distributing to an operating charity. Critics argue that this keeps funding invested in donor-advised funds indefinitely, at the expense of current impact in the community. However, other commentators caution that too strict a timing rule will reduce flexibility for foundations to best achieve their missions. The Council on Foundations has supported a five-year window for distributing donor-advised fund deposits.
Biden’s Proposal and Similar Efforts. Biden’s proposal would allow a grant to a donor-advised fund to count as a qualifying distribution only if:
- the funds are distributed by the donor-advised fund by the end of the next taxable year; and
- the private foundation keeps adequate records showing that the funds were, in fact, distributed by the donor-advised fund.
This would look fairly similar to the redistribution rules mentioned above, for grants from private foundations to other private foundations.
Last summer, the Accelerating Charitable Efforts Act (ACE Act) was introduced, and it included a number of changes to the donor-advised fund landscape—including a similar proposal around private foundation qualifying distributions. In addition, the IRS has long been concerned with this issue, and highlighted it for public comments in its most recent guidance on donor-advised funds.
Related Issue of Anonymous Giving. Another argument against private foundation use of donor-advised funds concerns anonymous giving. Private foundation grantees must be disclosed on the foundation’s 990-PF, which is publicly available—but grants from a donor-advised fund will be collectively shown on a sponsoring organization’s Form 990 without identifying which specific fund made the distribution. Critics argue this allows private foundations to hide grants to controversial organizations such as hate groups.
Others, however, point out there can be legitimate reasons for anonymous giving—including wanting to avoid becoming more solicited for grant funding, and wanting to avoid backlash for donations for permissible but controversial support of liberal or conservative causes. Notably, Biden’s proposal and others would not change this aspect of donor-advised fund use for anonymity purposes, but future ones may incorporate this.
Leaffer Law Group will continue to monitor and provide updates on this issue.