Philanthropically minded individuals have become increasingly inclined to utilize a Donor-Advised Fund or DAF as a way to manage their charitable giving. DAFs can allow donors to make a contribution to the DAF which will then be managed and invested and the donor retains the ability to direct how the funds are distributed to charity. Recently, the IRS has proposed new regulations that broaden what arrangements are considered DAFs and what payments made by the DAF may be taxable distributions.
Definition of a Donor-Advised Fund
A DAF is a philanthropic vehicle administered by a public charity or sponsoring organization. It allows donors to make irrevocable charitable contributions, receive an immediate income tax deduction, and then recommend grants from the fund over time. Donors can direct how much money and when a charity will receive the money and decide how the money not donated is invested subject to the investment options offered by the fund.
The legal requirements of a DAF are contained in the Internal Revenue Code. IRC Section 4966 defines a DAF as a fund or account (i) which is separately identified by reference to contributions of a donor or donors, (ii) which is owned and controlled by a sponsoring organization, and (iii) 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.
Proposed Regulations
The proposed regulations broaden the definition of a DAF by clarifying or expanding the meaning of several key terms, including “advisory privileges,” “donor,” “donor-advisor,” and “distribution.” They also propose a new anti-abuse rule.
“Advisory Privileges”
The term “advisory privileges” is not defined under the present regulations. The proposed regulations provide that the determination of advisory privileges is a fact-based inquiry, and includes the following circumstances as examples where advisory privileges exist:
- The sponsoring organization allows a donor or donor-advisor to provide nonbinding recommendations regarding distributions from, or regarding the investment of assets held in, a fund;
- A written agreement states that a donor or donor-advisor has advisory privileges;
- A written document or any marketing material of the sponsoring organization made available to a donor or donor-advisor indicates that a donor or donor-advisor may provide advice to the sponsoring organization regarding the distribution or investment of amounts held by a sponsoring organization; or
- The sponsoring organization generally solicits advice from a donor or donor-advisor regarding the distribution or investment of amounts held in a fund.
“Donor” and “Donor-Advisor”
These terms are also undefined in the present regulations. A “donor” under the proposed regulations would include anyone making a contribution to a sponsoring organization’s fund, except for a public charity or governmental unit.
“Donor-advisors” would include persons appointed by donors to advise on fund distribution or investment. Investment advisors managing DAFs and a donor’s personal assets would fall under this definition. As a result, sponsoring organizations that permit donors to recommend investment advisors to manage DAF assets may be significantly impacted in certain circumstances, particularly if those investment advisors also provide advice to donors and donor-advisors with respect to their personal assets.
If the proposed definition of donor-adviser is adopted, any compensation or similar payments made from a DAF to pay an investment advisor who does not advise the sponsoring organization on all DAFs must be analyzed to determine whether it will trigger taxes for the sponsoring organization. Most likely, the proposed regulations will largely restrict DAFs from compensating donors’ personal investment advisors. This in turn might impact what DAFs individual donors choose or whether they want to use a DAF at all depending upon their interest in using a specific investment advisor.
“Distribution”
The proposed regulations expand the statutory definition of “distribution” to include any grant, payment, disbursement, or other transfer from a DAF. Further, they introduce the concept of “deemed distribution,” which is any use of DAF assets that results in a more than incidental benefit to a donor, donor-advisor, or related person or any expense charged solely to a DAF paid directly or indirectly to a donor, donor-advisor, or related person with respect to the DAF. Accordingly, any distribution not for charitable purposes, such as payment of fees to a donor-advisor to manage the DAF, may be a “deemed distribution” and subject a sponsoring organization to excise taxes.
“Anti-Abuse Rule”
The proposed anti-abuse rule is intended to address instances where a donor controls where the donation goes after it goes to the charity. It gives the IRS the ability to look at how the charity spent the money and treat a series of distributions as a single distribution if the result is inconsistent with the intent of the statute.
As an example, if a donor recommends a distribution to a charity and the donor then arranges for the charity to make distributions to individuals recommended by the donor, for example the donor serves on a board or steering committee of the receiving charity which makes determinations as to the issuance of grants, the initial DAF distribution will be considered a taxable distribution from the DAF to individuals.
Conclusion
If the regulations are approved, they will potentially impact how DAFs operate, how certain sponsoring organizations manage their funds, and how individuals choose to participate. At this time, we will continue to monitor the status of the regulations and provide updates as needed. If you have any questions about how you may be impacted or you wish to discuss other charitable giving strategies, please contact us for a consultation.
