November 11, 2021 - Charitable giving via donor-advised funds ("DAFs") provides donors with a cost-efficient way to obtain tax deductions. DAFs are owned and controlled by sponsoring organizations (a "Sponsoring Organization") such as Fidelity Charitable or Schwab Charitable, which distribute gifts received from donors to public charities like the American Red Cross based on "non-binding" recommendations from such donors. Under current law, these gifts could remain inside DAFs for years before distribution to charity.
DAFs provide donors a streamlined procedure for making charitable gifts without the added cost of creating and operating a private foundation. While private foundations give donors more control over the investment and use of funds, they are subject to minimum distribution rules, annual accounting and tax filings and excise tax penalties for several categories of mismanagement.
Contributors to DAFs are free from these costs and burdens since the Sponsoring Organization controls the donated funds. In addition, donors can deduct more of their contributions to DAFs as the adjusted gross income percentage limit for gifts to DAFs is higher than gifts to private foundations. Sponsors in return gain the opportunity for investment management fees with respect to assets not yet distributed to charity.
Because DAFs are not required to make minimum distributions each year, critics refer to their use as a "significant detour" from the path between a donor's income tax deduction and the ultimate receipt of the gift by a public charity (e.g., R. Madoff, "Tax Write-Off Now, Charity Later," N.Y. Times (Nov. 22, 2011)). In response, Senators Angus King and Charles Grassley introduced on June 9, 2021, the Accelerating Charitable Efforts Act (the "ACE Act"), which creates new types of DAFs, restricts the flexibility of DAF sponsors, and mandates specific timelines for the distributions of funds held by any DAF. This article will discuss these new legislative proposals.
The ACE Act, if enacted, would be the first legislation referencing DAFs since 2006, when the Pension Protection Act requested a study of DAF operations. Most significantly, the ACE Act proposes a reformulation of the type of entity that qualifies as a DAF and would impose limitations on the timing and number of charitable deductions taken by DAF donors.
The Ace Act sharply limits current DAFs and creates two new classes of DAFs. The ACE Act begins by disallowing the charitable deduction for gifts to most currently existing DAFs. Any gift to a DAF, as currently defined in Code Section 4966(d)(2) but not falling into either new category of DAFs discussed below, would be treated as gifts to a "Non-Qualifying Donor Advised Fund." Gifts to such nonqualified DAFs could still offer a charitable deduction to donors, but only under certain circumstances and limitations:
•No deduction is allowed for a donor after the contribution of property other than cash until the Sponsoring Organization sells said property for cash;
•No deduction is allowed to the donor for any year until the year the Sponsoring Organization actually makes a distribution of donated cash (or the proceeds of a non-cash donation) to charity; and
•If the first two requirements are met, the available deduction for a given year is further limited to the amount actually distributed by the Sponsoring Organization to charity.
The ACE Act then creates two forms of permissible DAF distributees through which the donor may retain advisory privileges over terms of years and to which a charitable deduction might be allowed immediately, but with additional restrictions.
Qualified DAF #1.A Qualified Donor-Advised Fund (a "Qualified DAF") is a fund that requires the termination of the donor's advisory privileges after 14 years elapse from the date of the gift. Gifts of "non-publicly traded assets" to Qualified DAFs would not be eligible for a charitable deduction until the Sponsoring Organization sells the donated assets.
Qualified DAF #2.A Qualified Community Foundation Donor-Advised Fund (a "Community Foundation") is a fund "organized and operated for the purpose of understanding and serving the needs of a particular geographic community that is no larger than 4 states." Donors to Community Foundations may retain advisory privileges, but only if their total donated funds, aggregated across separate accounts, are less than $1 million (adjusted for inflation). Donors may not generally retain any advisory privileges if their DAF-held funds exceed $1 million. However, if the Community Foundation and donor agree that the Community Foundation will distribute at least 5% of the donor's total donated funds each year, then these larger donors can maintain and exercise advisory privileges.
The ACE Act subjects DAFs to excise taxes and restrictions similar to private foundations.In addition to the new definitions for nonqualified and permissible DAFs, and corresponding charitable deduction limitations, the ACE Act includes changes beyond those the IRS and Treasury had considered in Notice 2017-73. For example, the ACE Act would tie DAFs more closely to the existing regime for regulating private foundations.
The Code currently provides a series of prohibited acts and an enforcement regime for private foundations based on punitive excise taxes in the event of a breached rule, such as engaging in self-dealing transactions, or making jeopardizing investments, among others.
In addition, the proposed legislation would impose excise taxes on DAFs for failure to make annual minimum distributions similar to private foundations. The ACE Act exempts Community Foundations from this tax if they meet certain requirements, but any Qualified DAF would be subject to the tax if it fails to distribute the required amount of funds within 14 years. The ACE Act also subjects Non-Qualifying Donor Advised Funds to the 50% excise tax on amounts not distributed within 49 years.
The ACE Act comes four years after the IRS attempted to promulgate rules pushing back on perceived inefficiencies and potential for abuse by DAF donors.Notice 2017-13 stated that the IRS was "considering developing" regulations to address the following topics:
(1) Prohibiting the use of DAF funds to pay for the purchase of tickets that enable a donor, donor advisor, or related person under Code Section 4958(f)(7) to attend or participate in a charity-sponsored event that results in the donor's receipt of any more than an incidental benefit under Code Section 4967 (for example, by paying for a ticket to an event that includes dinner);
(2) Only allowing the distribution of DAF assets to settle a pledge made by a donor, donor advisor, or related person if the donor receives no more than incidental benefits under Code Section 4967; and
(3) Preventing substantial contributors to publicly supported charitable organizations from using DAFs as intermediaries to circumvent the "public support" requirements (the "Public Support Test") for favorable characterization as "public charities."
The third item above would require public charities to look through gifts from DAFs and identify the donor-advisor for purposes of the Public Support Test, a metric by which the IRS classifies exempt organizations. This test is significant because a donation to a DAF from a donor with an existing relationship to the charitable organization might not be considered public support, which could threaten the charitable organization's tax characterization as a public charity (and risk being treated as the less tax-advantageous private foundation). These rules would also require that a DAF gift without an identified donor be treated as anonymous and lumped with any other anonymous gifts received, making it more difficult to pass the Public Support Test.
Notice 2017-73 also asked for public comments regarding whether a gift to a DAF from a private foundation should be included when determining whether the private foundation met its minimum distribution requirements in a given tax year. Since its release, the IRS took no further action to develop final regulations.
While the ACE Act includes several new proposals, it incorporated some of the rules suggested by the IRS in Notice 2017-73, albeit with modification. For the Public Support Test, the ACE Act generally adopts the Notice's proposals, with the added exception that a DAF can certify it did not make a particular distribution based on a donor's advice.
If the DAF's decision is independent, that donation is public support. This exception allows DAFs to make some contributions to charity without impacting organizations' Public Support Test calculations.Notice 2017-73 overlooked that scenario. Another significant change is that a private foundation's gifts to a "Non-Qualifying" DAF will not count toward its distribution requirement.
The ACE Act proposes to compress the timeline for gifts to DAFs, bringing disbursements to charitable recipients closer to donor-received tax benefits. New oversight may resemble private foundation excise taxes, but with novel mechanisms.
While critics assert that charitable recipients may be harmed because the added complexity may dissuade donors from using DAFs for future gifting and reduce the number of institutions that will be willing to operate DAFs, proponents believe that limiting the use of DAFs will accelerate distributions of charitable funds to "operating" charities and, thus, for public benefit. Ultimately, though, the use of DAFs still comes down to whether your client desires to make charitable gifts and in consideration of which gifting vehicle best meets a client's long-term objectives.