While donor-advised funds (“DAFs”) have been a subject of scrutiny for more than 10 years now, no substantial legal changes have emerged since the Pension Protection Act of 2006 first introduced these charitable giving vehicles to heightened regulation. However, a recent proposal for new requirements for DAFs is facing pushback from organizations including the Council on Foundations.
DAF Basics. Donor-advised funds allow an individual to make a charitable contribution to a 501(c)(3) public charity (known as a sponsoring organization) and take an immediate tax deduction. The donor has the right to make ongoing advisory recommendations on organizations to receive grants from the fund, which allows the donor to delay decisions about specific recipients or causes they’d like to benefit. However, the sponsoring organization owns the fund and ultimately has discretion about where funds go—though practically speaking donor advisements are generally honored, so long as they don’t violate any restrictions. Many sponsoring organizations are community foundations, though technically any public charity can act as such.
The Pension Protection Act of 2006. This legislation put a standard definition into place for DAFs for the first time, and instituted key regulatory restrictions. A donor-advised fund is defined in the Internal Revenue Code as a fund or account:
- which is separately identified by reference to contributions of a donor or donors,
- which is owned and controlled by a sponsoring organization, and
- with respect to which a donor (or any person appointed or designated by such donor) has, or reasonably expects to have, advisory privileges with respect to the distribution or investment of amounts held in such fund or account by reason of the donor’s status as a donor.
The law now prohibits distributions from DAFs to individuals, though there is a safe harbor provision that can allow for scholarship activity so long as specific requirements are met—most notably, that donors cannot control the selection process. Further, expenditure responsibility—a heightened due diligence process that private foundations must sometimes use—is now required for certain grants from DAFs, as well.
Recent Proposal and its Critics. A recent letter from two law professors to the Senate Finance Committee argues for a few new DAF requirements and restrictions, namely a mandatory payout period for all funds and a prohibition on private foundations being able to satisfy their payout requirements by making distributions to DAFs. Both proposals are couched in the premise that DAFs allow donors to stockpile funds for which they’ve garnered a charitable donation, rather than putting them out into the charitable community.
However, the follow-up letter from community foundations and other interested organizations highlights some important points. First of all, even without any sort of payout requirement, there is no evidence to support that this stockpiling is actually occurring. Further, there is no real incentive for donors to do so—they’ve already obtained a tax benefit from their contribution. Rather, many are developing philanthropic plans or strategies and are making distributions in furtherance of that. And there are some good reasons why distributions may not get started right away or may be suspended—for instance, letting a fund accumulate to make a larger grant, or to develop a long-term plan. Other times, family circumstances may require it—for example, a memorial fund may be set up after a loved one’s death, but the relatives emotionally may not be ready to engage in grantmaking for some time. It is worth noting, as well, that sponsoring organizations wishing to be accredited under the National Standards for U.S. Community Foundations accreditation process are required to have a policy addressing inactive funds—in other words, it isn’t necessarily in the sponsoring organizations’ interest to have DAFs just gathering dust.
Further, the letter argues that allowing private foundations to make grants to DAFs can lead to more effective use of charitable funds. For example, private foundations may make grants to local DAFs in order to conduct local philanthropy with close community partners. And small family foundations without staff may utilize DAFs in order to be able to support more charities through grantmaking—taking advantage of the sponsoring organizations staff and processes.
A Separate Issue. A more pressing issue, in our minds, is the lack of follow-up guidance from the IRS on donor-advised funds. It has been more than 10 years since the PPA was passed, and questions linger as to whether certain funds like giving circles fall under the DAF definition, and whether the restriction on distributions to individuals prohibits payment of legitimate expenses from the fund (e.g., for a fundraiser). In addition, clarification of the prohibited benefit restriction would be welcome. We’d like to see follow-up on these items, rather than “solutions” to issues that are not clearly problematic.