Donor-advised funds (DAFs) have gained popularity as a philanthropic tool in recent years. And it isn’t surprising—DAFs offer donors a flexible giving option when they want a charitable deduction with administrative simplicity and a long-term distribution of funds.
But the IRS has indicated it suspects a number of organizations and individuals are taking advantage of DAFs. Because of this, the IRS has provided a notice that warns of tightening its restrictions on the funds.
A DAF is a separately-identified and managed account that’s operated by a section 501(c)(3) public charity—a sponsoring organization—on the original donor’s behalf.
Once a donor contributes to a DAF, the sponsoring organization has legal control over the funds. The organization then invests the funds until the donor advises that they be distributed. Donors often need to follow specific guidelines when advising about the distribution of funds, but a sponsoring organization has ultimate control.
Despite the benefits DAFs offer, the charitable sector has been expecting the IRS to tighten restrictions on DAFs for some time as the most recent—and only—guidance on DAFs came with the Pension Protection Act of 2006.
Perceived Abuse of DAFs
The IRS has indicated individuals and organizations may be taking advantage of the benefits DAFs provide in the following ways:
- To generate questionable charitable deductions
- To provide impermissible economic benefits to donors and their families or excess management fees for promoters
- To circumvent public support requirements of public charities
- To provide a way for private foundations to circumvent minimum distribution requirements
- To keep funds out of the active charitable sector by parking money in accounts where there isn’t a requirement to distribute
Next Steps from the IRS
According to Notice 2017-73, issued in December 2017, the IRS and Treasury Department are considering regulations to address perceived abuses of DAFs, including some of the above issues. The notice provides stipulations in the following areas:
Sponsorship or Membership Benefits for Donors
The notice prohibits distribution from a DAF pursuant at the advice of a donor or advisor—referred to throughout the notice as donor—if the DAF subsidizes the donor’s attendance or participation in a charity-sponsored event or membership in a charity.
This restriction applies because it’s a benefit that’s more than incidental. Donors can only receive an incidental benefit from distributions that are made from DAFs. The term incidental is not otherwise defined by the IRS so this restriction provides more dimension to the limits of such benefit. The donor would be taxed 125% on this transaction, and the fund manager who permitted the transaction would be taxed 10%.
Pledges Made by Donors
If a DAF distributes to a charity, and that charity uses the funds to relieve a pledge obligation promised by the DAF’s donor, the DAF will not be considered to provide the donor with a benefit that’s more than incidental.
The guidance provides a clear example of a benefit that would be incidental and, therefore, not expressly prohibited. This rule stems from the difficulty of assessing whether the outstanding pledge existed before the donor granted the DAF to the recipient. For this to hold true, the following circumstances must apply:
- The recipient didn’t make reference to the pledge when making the DAF distribution
- The donor didn’t receive any other benefit from the distribution
- The donor didn’t attempt to take a charitable contribution deduction, even if the grantee directly sent an acknowledgement to the donor
Circumventing Public Support
Donors may no longer have the option of using a DAF to anonymize their contribution to a public charity. The notice indicates that the IRS will consider treating a distribution from a DAF as an indirect contribution from the donor—or donors—that funded the DAF, rather than as the sponsoring organization’s support of a public charity.
If a public charity receives funding from another public charity, the income is generally considered unlimited public support. But in this scenario, if IRS treats the DAF as a donation from the original donor, public support would be limited.
Provide Your Input
In Notice 2017-52, the IRS has also requested comments about the relationship between DAFs and private foundations. Comments, in combination with data they pull from Form 990-PF reporting, could determine their future actions. Specifically, the IRS wants to know:
- How private foundations use DAFs in support of their purposes
- Whether a private foundation’s transfer of funds to a DAF should only be treated as a “qualifying distribution” if the DAF-sponsoring organization agrees to distribute the funds for charitable purposes—or to transfer the funds to its general fund—within a certain timeframe.
Comments on the above information may be submitted by March 5, 2018, to firstname.lastname@example.org, or to the following address:
Internal Revenue Service
CC:PA:LPD:PR (Notice 2017-73) Room 5203
P.O. Box 7604, Ben Franklin Station,
Washington, DC 20044s
Please include “Notice 2017-73” in the subject line. Comments will be available for public inspection and copying.
The Future of DAFs
We expect the popularity of DAFs will continue to grow—especially as the tax landscape evolves. DAFs continue to be a great philanthropic tool for individuals and foundations, so restricting the use could have a wide impact. If you have strong opinions on the matter, now’s the time to let the IRS know.
We’re Here to Help
For more information about the new restrictions or to learn how changes to DAFs could affect you and your business, contact your Moss Adams professional.