The Internal Revenue Service (the “IRS”) has issued Notice 2017-73 (the “Notice”) which outlines approaches the Department of the Treasury (“Treasury”) and the IRS are considering with respect to the regulation of certain issues relating to Donor Advised Funds (“DAFs”). Written comments on the issues raised in the Notice may be submitted by March 5, 2018.
In recent years, DAFs have become popular philanthropic vehicles and, in some cases, useful alternatives to private foundations. Section 4966 of the Internal Revenue Code (the “Code”) generally defines a DAF as a fund or account owned and controlled by a 501(c)(3) public charity “sponsoring organization” which (i) is separately identified by reference to contributions of a donor or donors and (ii) with respect to which the donor, or any person appointed or designated by such donor (such person, a “donor advisor”) has, or reasonably expects to have, advisory privileges with respect to the distribution or investment of funds. The Code generally imposes a series of excise taxes on certain distributions from DAFs, including for distributions which (i) serve non-charitable purposes (Code Section 4966), (ii) generate directly or indirectly a more than incidental benefit for donors, donor advisors or certain related persons (Code Section 4967) and (iii) constitute an “excess benefit transaction” (Code Section 4958).
The Notice is intended to provide interim guidance on the specific areas discussed and to solicit comments while Treasury and the IRS continue to develop proposed regulations for DAFs generally. The Notice discusses the following three areas for regulations that Treasury and the IRS are considering:
Distributions Providing a More than Incidental Benefit to a Donor, Donor Advisor or Related Person
Section 3 of the Notice addresses whether a distribution from a DAF to a 501(c)(3) public charity that enables a donor, donor advisor or related person (referred to below as “Donor/Advisors”) to attend or participate in an event results in such person receiving a more than incidental benefit. This issue arises when, for example, a Donor/Advisor makes a grant recommendation from a DAF that enables the Donor/Advisor to receive performance tickets at the symphony or pay for a table at a fundraiser. In general, the payment of the “non-charitable” portion of the ticket—that is, the cost of the performance or the dinner itself—is not deductible and would seem to be a direct benefit provided to the Donor/Advisor through the use of DAF funds. In order to avoid this problem, Donor/Advisors sometimes split the cost of an event ticket in two—seeking to have the “charitable” portion of the ticket paid with DAF assets and the “benefit” portion paid directly by the Donor/Advisor.
The Notice states that Treasury and the IRS view the payment of a portion of the ticket by the DAF as relieving the Donor/Advisor of the obligation to pay the full price and can be considered a direct benefit and would be taxable under Code Section 4967. The same applies to the use of DAF assets to pay for the deductible portion of a membership fee, which would also be deemed to confer more than an incidental benefit. In short, the “bifurcation” of a ticket cost or membership fee between its deductible and non-deductible portions would not be permissible. This interpretation is consistent with the approach taken by the IRS with respect to bifurcation in the private foundation context.
Use of DAF Assets to Satisfy the Charitable Pledge of a Donor, Donor Advisor or Related Person
Section 4 of the Notice addresses whether a distribution from a DAF to a 501(c)(3) public charity can be used to satisfy the charitable pledge of a Donor/Advisor or whether such distribution would constitute the provision of a more than incidental benefit under Code Section 4967. In the private foundation context, the use of private foundation assets to fulfill the legal obligation of a disqualified person ordinarily constitutes a prohibited act of self-dealing under Code Section 4941.
In the Notice, Treasury and the IRS discuss the difficulty of determining whether or not a Donor/Advisor has made a legally binding, enforceable pledge, or merely an expression of charitable intent. Therefore, the Notice states that proposed regulations under Code Section 4967 would, if finalized, provide that distributions from a DAF to a charity will not be considered to result in more than an incidental benefit to a Donor/Advisor under Code Section 4967 (regardless of whether the grantee charity treats the distribution as satisfying the pledge and regardless of whether the pledge is enforceable under current law), provided that:
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 (as discussed in the Notice and in any future proposed regulations) on account of the DAF distribution; and
a Donor/Advisor does not attempt to claim a charitable contribution deduction under Code Section 170(a) with respect to the DAF distribution, even if the grantee charity erroneously sends him or her a written acknowledgement of the distribution.
The Notice further states that taxpayers may rely on Section 4 of the Notice until additional guidance is issued. We note that the Notice makes clear that this special rule applies only for purposes of Code Section 4967 and the prohibition on such transactions by a private foundation remains, distinguishing between the close relationship between a private foundation and its disqualified persons and a DAF sponsoring organization and its Donor/Advisors.
Use of DAF Assets to “Avoid” Public Support Limitations
Section 5 of the Notice addresses how contributions from DAFs may be treated in certain circumstances by public charity recipients of DAF funds in calculating the recipient organization’s public support. In determining whether an organization is publicly supported, the organization generally may treat contributions from a person as public support only to the extent that such person’s total contributions to the organization during the taxable period do not exceed two percent of the organization’s total support during such period (the “two percent limitation”). Grants from a publicly supported organization described in Code Section 170(b)(1)(A)(vi) are not subject to the two percent limitation, except to the extent such contributions have been earmarked by a donor to be so contributed. Treasury and the IRS are concerned that some Donor/Advisors and grantee charities may seek to use the DAF sponsoring organization (generally a Section 170(b)(1)(A)(vi) publicly supported organization) as an intermediary to avoid the two percent limitations on the DAF contribution. The specific concern of Treasury and the IRS is that because one hundred percent of a DAF’s contribution can count towards public support for the grantee, a Donor/Advisor may contribute to a DAF and recommend a grant out of the DAF in order to avoid the two percent limit that would apply to a contribution made directly by the Donor/Advisor to the recommended grantee. Including one hundred percent of the grant from the sponsoring organization as public support boosts the public support percentage of the grantee, making it easier for it to achieve or maintain public charity status. The Notice states that Treasury and the IRS are considering changes to the Treasury Regulations (Sections 1.170A-9(f) and 1.509(a)-3) to provide that a donee organization, for purposes of determining its amount of public support would need to treat:
a sponsoring organization’s distribution from a DAF as coming from the donor (or donors) that funded the DAF rather than from the sponsoring organization;
all anonymous contributions received (including a DAF distribution for which the sponsoring organization fails to identify the donor that funded the DAF) as being made by one person; and
distributions from a sponsoring organization as public support without limitation only if the sponsoring organization specifies that the distribution is not from a DAF or states that no donor or donor advisor advised the distribution.
This proposal would constitute a dramatic change in how contributions from DAFs are treated with respect to the public support test, not least by differentiating, for public support purposes, between distributions recommended by Donor/Advisors and distributions from sponsoring organizations that are not so recommended.