- Proposed regulations could cause significant disruptions to Donor Advised Funds (DAFs).
- Role of personal investment advisors potentially severely restricted.
- Key aspects of DAF operations remain unanswered.
- Donors, investment advisors, and DAF sponsors should submit comments by Jan. 16.
Donor advised funds (DAFs) are wildly popular with donors because they reduce the costs and administrative burdens of charitable grants and investing, thereby increasing amounts available for charitable giving. Since 2009, grantmaking from DAFs has increased every year and has more than doubled in the past five years. Grants and contributions from DAFs recently exceeded $52 billion.
On Nov. 13, the U.S. Department of the Treasury (Treasury) released the first in what is expected to be a series of long-awaited regulations interpreting the statute that codifies DAFs, which Congress enacted in the Pension Protection Act of 2006. The proposed regulations establish fundamental concepts and definitions that will be used in forthcoming guidance to address nearly every aspect of DAF regulation. But, as explained below, the proposed regulations do not address some of the issues most important to donors and organizations that sponsor DAF programs.
The Statutory Framework
The Pension Protection Act formally recognized DAFs as charitable giving vehicles codified in the Internal Revenue Code (Code), putting an end to questions of the legitimacy of DAFs, which have been in use for more than a century. Section 4966(d)(2)(A) of the Code defines a DAF as a fund or account:
(i) That is separately identified by reference to contributions of a donor or donors,
(ii) That 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 regard to the distribution or investment of amounts held in such fund or account by reason of the donor’s status as a donor.
Section 4966(d)(1) defines a sponsoring organization as a public charity that maintains one or more DAFs.
Section 4966(c) also imposes excise taxes on a sponsoring organization (and under certain circumstances on the managers of the DAF) on “taxable distributions” from the DAF.
The Proposed Regulations
The proposed regulations primarily set the stage for future rulemaking by addressing fundamental definitional questions.
Definition of DAF and ‘Advisory Privileges’
The proposed regulations build on the statutory definition of a DAF by explaining that a fund or account is “separately identified by reference to contributions of a donor or donors” if the sponsoring organization maintains a formal record of contributions to the fund from each donor or donors or, if there is no formal record, the facts and circumstances otherwise show such fund or account is separately identified. The proposed regulations set forth factors to consider in a facts and circumstances analysis.
The proposed regulations also explain that the determination of whether a donor or donor-advisor has advisory privileges (or the reasonable expectation of advisory privileges) is also based on facts and circumstances, including both the conduct of and any agreement or understanding between the donor or donor-advisor and the sponsoring organization. Again, the proposed regulations set forth factors for a facts and circumstances analysis.
Notably, the proposed regulations state that a donor or donor-advisor will be deemed to have advisory privileges, even if not exercised, if any of the following is true:
(i) The sponsoring organization allows the donor or donor-advisor to make nonbinding recommendations regarding distributions or investments;
(ii) A written agreement provides such privileges;
(iii) The sponsoring organization has a written document or any marketing material indicating a donor or donor-advisor has such privileges; or
(iv) The sponsoring organization solicits advice from the donor or donor-advisor regarding distributions or investments.
In addition, the proposed regulations state that if a sponsoring organization names a donor, a donor-advisor or a related person to a committee with authority to advise on distributions or investments, that appointment also will be considered to give rise to advisory privileges for purposes of the DAF rules unless specific criteria are met.
The proposed regulations also contain specific exceptions for scholarship funds and disaster relief funds.
What This Means
- For a multi-donor fund, if no donor has, or reasonably expects to have, advisory privileges, the fund is not a DAF.
- A fund that only makes distributions to a single public charity or a governmental entity is not a DAF. Importantly, for this exception to apply as proposed, the distributions must be made directly to the single entity and not to other organizations on behalf of such entity.
- Entities holding “field of interest” funds and “fiscal sponsorship” funds should determine whether existing funds come within the proposed definition of a DAF.
- The proposed regulations provide that a person may have advisory privileges regarding distributions and investments even if that person did not and does not contribute to the fund.
- A donor’s participation on a committee with advisory privileges regarding distributions and investments may cause a fund to be treated as a regulated DAF.
- While a donor-restricted gift is not necessarily treated as a DAF, if the nature of the restriction gives the donor (or someone else) significant input into the charity’s use of the gift, the gift could be considered a DAF.
Definition of ‘Donor’ and ‘Donor-Advisor’
The proposed regulations define “donor” as any person or entity, other than a public charity or governmental entity, that contributes to a fund at a sponsoring organization.
“Donor-advisor” is defined as a person appointed by a donor (or another donor-advisor), including by delegation, to have advisory privileges regarding distributions or investments.
One of the more controversial provisions in the proposed regulations provides that an investment advisor is considered a donor-advisor if such advisor provides personal investment advice to a donor and investment advice with respect to the assets in a specific DAF. The proposed regulations clarify that an advisor who provides investment advice to a sponsoring organization for all its DAFs does not meet this definition. As with the other definitions above, the proposed regulations suggest a facts and circumstances analysis to determine whether a particular advisor is a donor-advisor for purposes of this rule.
What This Means
- Because public charities and governmental entities are not donors, accounts funded by these entities are not DAFs, nor are accounts over which these entities have advisory privileges.
- Certain investment advisors would come within the proposed definition of donor-advisor, so compensation to such advisors from the DAF would be prohibited.
Definition of Taxable Distribution
The proposed regulations adopt the statutory definition of a “taxable distribution” as any distribution from a DAF to a natural person or any entity other than a public charity for a purpose not specified in Section 170(c)(2)(B) of the Code or over which the sponsoring organization does not exercise expenditure responsibility.
The proposed regulations include a “substance over form” rule that would treat a series of distributions as a single taxable distribution if the series of transactions was meant to avoid the excise tax.
What This Means
- “Distribution” was previously undefined. Given the broad definition adopted by the proposed regulations, certain direct transactions may need to be evaluated to determine if they would be considered a taxable distribution.
- The regulations echo the “expenditure responsibility” rules for private foundations and should provide clarity on the process to be followed by donor-advisors and sponsoring organizations that wish to use a DAF to support an entity other than a public charity.
What Is Not in the Proposed Regulations?
While Treasury acknowledges previously issued guidance – namely Notice 2017-73, which addressed distributions from a DAF to pay for the purchase of tickets to an event or to fulfill a pledge – the proposed regulations do not address these important issues.
The proposed regulations also do not address any of the more sweeping proposed changes in the Accelerating Charitable Efforts Act, nor do the proposed regulations otherwise address any of the other more controversial aspects of DAFs, such as the lack of a mandatory distribution requirement.
What Is Next?
These proposed regulations will be effective for taxable years ending after the date on which final regulations are published in the Federal Register. As written, the proposed regulations do not include any transition rules, which means that the regulations could become effective in the middle of a tax year. Taxpayers are entitled to rely on the proposed regulations because the IRS will not take positions inconsistent with proposed regulations even if those regulations do not yet have the force of law.
Interested parties can submit comments and requests for a public hearing through Jan. 16, 2024. Online submission of comments is encouraged, using this link: https://www.federalregister.gov/documents/2023/11/14/2023-24982/taxes-on-taxable-distributions-from-donor-advised-funds-under-section-4966.