Proposed regulations issued by the IRS on November 13, 2023, provide a definition of a donor-advised fund, exceptions to what’s a donor-advised fund, and guidance on taxable distributions related to donor-advised funds.
While the guidance relates specifically to the taxable expenditure rules under Internal Revenue Code (IRC) Section 4966, the definitions will have broader implications when guidance is issued later for IRC Section 4967 and excess benefit transactions with donors, donor-advisors, and fund managers.
In general, donor-advised funds are accounts set up at a charitable organization—known as a sponsoring organization—by a donor, who may then provide nonbinding recommendations on distributions from the account and on how the account’s assets are invested.
The proposed regulations don’t address all issues surrounding donor-advised funds, and additional guidance is anticipated.
Background
The Pension Protection Act (PPA) of 2006 enacted several amendments to the IRC related to donor-advised funds. IRC Section 4966 was added to impose excise taxes on taxable distributions made by sponsoring organizations from a donor-advised fund. IRC Section 4967 was added to impose excise taxes on prohibited benefits resulting from distributions from donor-advised funds.
The PPA amended IRC Section 4958 to add rules relating to excess benefit transactions with donor-advised funds. An excess benefit transaction occurs when a tax-exempt organization undertakes a transaction that directly or indirectly provides a benefit to a disqualified person that exceeds the value of the consideration received for that benefit.
Soon after the adoption of the PPA, the IRS issued Notice 2006-109, which provided interim guidance on certain requirements of the PPA, including those related to donor-advised funds. This notice sought comments and suggestions for future guidance.
In 2007, the IRS issued Notice 2007-21, which requested comments on a joint study by the IRS and Department of the Treasury on the organization and operation of donor-advised funds and supporting organizations. In December 2017, the IRS issued Notice 2017-72, which described possible approaches to issues surrounding donor-advised funds and seeking comments on those approaches.
The proposed regulations, issued in November 2023, mostly address IRC Section 4966, and don’t address many other issues surrounding donor-advised funds.
Definition of a Donor-Advised Fund
A donor-advised fund is a fund or account that meets all of the following criteria:
- Separately identified by reference to contributions of a donor or donors
- Owned and controlled by a sponsoring organization
- At least one donor or donor-advisor has, or reasonably expects to have, advisory privileges over the distribution or investment of amounts held in the fund, by reason of the donor’s status as a donor
The proposed regulations provide further definitions and guidance related to these criteria.
Separately Identified
A fund is considered separately identified if the sponsoring organization keeps a formal record of contributions to the fund relating to the donor or donors. If no formal record is maintained, then facts and circumstances determine whether a fund is separately identified.
Relevant facts and circumstances, under the proposed regulations, include the following:
- The fund balance reflects items such as contributions, dividends, interest, distributions, administrative expenses, and realized or unrealized gains or losses
- The fund is named after one or more donors, donor-advisors, or related persons
- The sponsoring organization refers to the fund as a donor-advised fund
- The sponsoring organization has an agreement with one or more donors or donor-advisors that the fund is a donor-advised fund
- One or more donors or donor-advisors regularly receive a fund statement from the sponsoring organization
- The sponsoring organization generally solicits advice from the donors or donor-advisors before making distributions from the fund
The donor-advised fund can be commingled with other assets of the sponsoring organization, as long as the fund is attributed to contributions of a donor or donors.
Sponsoring Organization
A sponsoring organization, under the proposed regulations, is any charitable organization described in IRC Section 170, except for a governmental unit, and it can be a foreign organization. In addition, a sponsoring organization must maintain one or more donor-advised funds, and can’t be a private foundation.
Donor
The proposed regulations define a donor as any individual, trust, estate, partnership, association, company, or corporation that contributes to a fund of a sponsoring organization. However, a donor doesn’t include:
- Any public charity, except for a disqualified supporting organization
- Any governmental unit
Donor-Advisor
The proposed regulations define a donor-advisor as someone named by a donor to have advisory privileges on the distribution or investment of assets in a donor-advised fund. If a donor-advisor delegates advisory privileges to someone else, that person also becomes a donor-advisor. No particular form of appointment is required.
In addition, a person who sets up a fund and advises on the distributions or investments of the fund is a donor-advisor, regardless of whether the person donates to the fund.
Also considered a donor-advisor is an investment advisor who provides investment advice for both the fund and the donor’s personal assets, regardless of whether the donor appointed the investment advisor. There’s an exception for when the investment advisor also provides services to the sponsoring organization as a whole and not just the fund.
Finally, a person recommended by a donor or donor-advisor and appointed by the sponsoring organization to serve as a member of a committee advising on the distributions or investments of a fund is also a donor-advisor. This rule doesn’t apply if all the following are true:
- The recommendation to serve on the committee is based on objective criteria related to the member’s expertise in the field of interest of the fund
- The committee has three or more members, and a majority of the committee isn’t recommended by the donor or donor-advisor
- The recommended person isn’t related to the donor or donor-advisor
Related Person
A related person includes spouses; ancestors; grandchildren; great-grandchildren; the spouses of children, grandchildren, and great-grandchildren; and siblings, half-siblings, and their spouses. A related person is also a 35% controlled entity by the donor, donor-advisor, and their family members.
Distribution
The proposed regulations define a distribution as any grant, payment, disbursement, or transfer from a donor-advised fund. However, investments and reasonable fees related to grants or investments aren’t distributions.
The preamble to the proposed regulations clarifies the following:
- Any use of donor-advised fund assets that provide a more than incidental benefit to a donor would be deemed a distribution that likely would be considered a taxable distribution
- Zero-interest loans don’t qualify as investments; expenditure responsibility rules apply if the loan isn’t to a charitable organization for which expenditure responsibility isn’t required
- Unreasonable investment and grant-related fees paid from donor-advised fund assets are taxable distributions
- An expense charged solely to a particular donor-advised fund paid, directly or indirectly, to a donor, donor-advisor, or related person with respect to the donor-advised fund, is subject to the taxable expenditure and excess benefit rules
Advisory Privileges
The existence of advisory privileges is based on the facts and circumstances, which depend on the conduct of both the donor or donor-advisor and the sponsoring organization. Advisory privileges include those arising from serving on an advisory committee, and a donor or donor-advisor may have advisory privileges despite not actually providing advice.
The proposed regulations list the following facts as sufficient to show that a donor or donor-advisor has advisory privileges:
- The sponsoring organization allows a donor or donor-advisor to provide nonbinding recommendations on the distributions and investments of the fund
- A written agreement between the sponsoring organization and a donor or donor-advisor says the donor or donor-advisor has advisory privileges
- A written document or marketing material from the sponsoring organization available to a donor or donor-advisor indicates a donor or donor-advisor may provide advice on distributions or investments of the fund
- The sponsoring organization generally solicits advice from a donor or donor-advisor on distributions or investments of the fund
The proposed regulations also provide four special rules on advisory privileges.
First, if at least one donor or donor-advisor has advisory privileges, advisory privileges by reason of the donor’s status as a donor exist, even if there are multiple donors to the fund.
Second, a sponsoring organization’s appointment of a donor, donor-advisor, or related person to an advisory committee for the fund will result in advisory privileges unless:
- The appointment is based on objective criteria related to the appointee’s expertise in the field of interest of the fund
- The committee has three or more members, not more than one-third of whom are related persons
- The appointee isn’t a significant contributor to the fund at the time of appointment, considering donations from related persons
Third, advice provided by a person who serves as an officer, director, or employee of a sponsoring organization doesn’t automatically result in advisory privileges. But if the officer, director, or employee is allowed to advise because of their contributions to the fund, they have advisory privileges.
Fourth, unless the third rule applies, if a donor is the only person with advisory privileges for a fund, advisory privileges are by reason of the donor’s status as a donor.
In some cases, a donor’s direction for a gift might not rise to the level of advisory privileges. Under an example in the preamble to the proposed regulations, a donor who earmarks a contribution at the time it’s made to a fund or program of a charitable organization doesn’t establish an advisory privilege that would require the gift to be treated as a donor-advised fund. The IRS is requesting comments on circumstances related to a gift agreement or advisory rights that could create an advisory privilege.
Exceptions to the Definition of a Donor-Advised Fund
Consistent with IRC Section 4966, the proposed regulations state that a donor-advised fund doesn’t include any fund that makes:
- Distributions only to a single identified organization
- Certain grants to individuals for travel, study, or other similar purposes
The proposed regulations provide two further exceptions to the definition of a DAF:
- An exception for certain scholarship funds where the committee is nominated by a Section 501(c)(4) organization with broad membership
- An exception for disaster relief funds
- An exception for certain scholarship funds where the committee is nominated by a Section 501(c)(4) organization with broad membership—Section 501(c)(4) organizations are formed to promote social welfare
Single Identified Organization
The single identified organization must be a public charity—except for disqualified supporting organizations—or a government entity. Some commenters had asked that a single identified organization also include non-public charities, as long as the distributions were made for a charitable purpose, but the IRS declined to expand the exception.
The distributions from the donor-advised fund must only be made to the single identified organization, and not to third parties on behalf of the single organization.
A fund won’t be treated as making distributions only to a single organization if the following occur:
- A donor, donor-advisor, or related person can provide advice to the single identified organization on its distributions
- A distribution from the fund will provide a more than incidental benefit to a donor, donor-advisor, or related person
Because a sponsoring organization might not be aware of the activities of a donor, donor-advisor, or related person, the proposed regulations allow it to rely on certification from the donor that they haven’t breached the above rules.
Grants to Individuals
The term donor-advised fund doesn’t apply to any fund in which a donor or donor-advisor advises on which individuals receive grants for travel, study, or similar purposes, if the following criteria occur:
- The sole purpose of the fund is to make grants to individuals for travel, study, or other similar purposes
- The donor or donor-advisor provides the advice exclusively in their capacity as a member of a selection committee
- The sponsoring organization appoints all members of the selection committee
- No combination of donors, donor-advisors, or related persons control the selection committee
- All grants from the fund are awarded on an objective and non-discriminatory basis, under a written procedure approved by the sponsoring organization’s board of directors
- The fund keeps adequate records that show the recipients were chosen on an objective and nondiscriminatory basis
A selection committee is considered controlled if the donor, donor-advisor, or related persons, either alone or together:
- Can require the committee to take or not take any action
- Control 50% or more of the committee’s voting power
- Can veto the committee’s decisions
Whether a donor, donor-advisor, or related persons indirectly control a selection committee is determined by the facts and circumstances.
Scholarship Funds Set Up by 501(c)(4) Organizations
For the exception of allowing a scholarship fund set up by a 501(c)(4) organization to not be a donor-advised fund, the following six conditions must be met.
- The fund’s single charitable purpose must be to grant scholarships to individuals
- The scholarship recipients are chosen by a selection committee whose members are nominated by the 501(c)(4) organization and approved in writing by the sponsoring organization
- The fund must serve a charitable class
- Scholarship recipients are chosen on an objective and nondiscriminatory basis, under a written procedure approved by the sponsoring organization’s board of directors
- No distribution can be made from the fund to any director, officer, or trustee of the sponsoring organization; any selection committee member; any member, honorary member, or employee of the 501(c)(4) organization; and any related persons
- The fund keeps adequate records that show the recipients were picked on an objective and nondiscriminatory basis
The IRS has concerns that by not requiring the 501(c)(4) organization to have a broad membership, a small group of people could bypass the donor-advised fund rules by setting up a 501(c)(4) organization and using a fund at a sponsoring organization to give scholarships.
The IRS is seeking comments on how to identify an organization as having a broad-based membership, along with comments on whether the exception should be allowed for other organizations, like 501(c)(5) and 501(c)(6) organizations.
Disaster-Relief Funds
A disaster-relief fund isn’t a donor-advised fund if the following conditions are met:
- The fund’s single charitable purpose is to provide relief from qualified disasters
- It serves a charitable class
- Recipients are chosen from a selection committee that isn’t directly or indirectly controlled by donors, donor-advisors, or related persons
- The sponsoring organization appoints the selection committee
- If it gives preference to employees or family members of an employer to receive grants, then a majority of the selection committee must be made up of people who don’t have substantial influence over the employer’s operations
- Recipients are chosen on an objective and nondiscriminatory basis under a written procedure approved by the sponsoring organization’s board of directors
- No distribution from the fund may result in a more than incidental benefit to any director, officer, or trustee of the sponsoring organization; any selection committee member; or any related person
- The sponsoring organization must maintain records that show the recipients’ need for the disaster relief and that satisfy reporting requirements related to disaster-relief activities
Taxable Distributions
A taxable distribution is any distribution from a donor-advised fund to any individual; or to any trust, estate, partnership, association, company, or corporation if:
- The distribution isn’t for a charitable purpose
- The sponsoring organization doesn’t exercise expenditure responsibility
Under expenditure responsibility, the sponsoring organization must make the effort and establish procedures to ensure the grant is spent for its purpose, to obtain complete reports from the grantee on how the funds are spent, and to make reports on the expenditures to the IRS.
A taxable distribution doesn’t include any distribution from a donor-advised fund to any charitable organization other than a disqualified supporting organization, the donor-advised fund’s sponsoring organization, or any other donor-advised fund.
Under the proposed regulations, distributions used for political campaign activity or lobbying would be taxable distributions since they are for a non-charitable purpose.
A distribution can’t be made through an intermediary organization to circumvent these rules. In an example from the proposal regulations, if a donor advises on a distribution from a donor-advised fund to a charity and then the donor or the sponsoring organization ensures that charity makes distributions to individuals, the distribution will be treated as a taxable distribution.
For grants made to non-charitable organizations, the grantee must agree to the following:
- To separately account for the grant funds on its books or to segregate the grant funds
- Not to make a grant to a person or organization that doesn’t comply with the expenditure responsibility requirements
- Not to make a grant, loan, compensation, or similar payment to a donor, donor-advisor, or related person with respect to the donor-advised fund from the granted funds
Disqualified Supporting Organization
The proposed regulations and IRC Section 4966 both define a disqualified supporting organization as one of the following:
- A Type III non-functionally integrated supporting organization
- Any other type of supporting organization if the donor, donor-advisor, or related persons with respect to the donor-advised fund directly or indirectly control a supported organization of the supporting organization.
The proposed regulations further state that a donor, donor-advisor, and related persons control a supported organization if they:
- Can require or prevent the supported organization from performing any act that significantly affects its operations
- Have 50% or more of the voting power of the supported organization’s governing body
- Have veto power over actions of the supported organization’s governing body
The IRS is seeking comments on whether other entities should be included in the definition of a disqualified supporting organization.
Taxes on Taxable Distributions
Consistent with IRC Section 4966, the proposed regulations say that for each taxable distribution, an excise tax of 20% of the amount of the taxable distribution is imposed on the sponsoring organization. Also, each fund manager who knowingly agrees to make the taxable distribution is liable for an excise tax of 5% of the amount of the taxable distribution, up to $10,000 per event.
Fund Manager
A fund manager is one of the following:
- An officer, director, or trustee of the sponsoring organization, or anyone with similar authority
- The employee who has final authority or responsibility with respect to any act, or failure to act, resulting in a taxable distribution
A fund manager is considered to have knowingly agreed to make a taxable distribution only if either of the following occur:
- The fund manager is aware it’s a taxable distribution
- The fund manager has knowledge that it could be a taxable distribution, but negligently fails to determine whether it is a taxable distribution
When more than one fund manager is liable for the 5% tax, all such fund managers are jointly and severally liable for the tax.
Applicability and Comments
Taxpayers may rely on the proposed regulations for taxable years ending before the date that final regulations are published in the Federal Register.
Comments and requests for a public hearing must be received by an extended date of February 15, 2024.
Electronic comments are preferred and can be submitted via the Federal eRulemaking Portal by following the online instructions for submitting comments. Requests for a public hearing must be submitted in the Comments and Requests for a Public Hearing section.
Paper comments can be sent to:
CC:PA:01:PR (REG-142338-07)
Room 5203
Internal Revenue Service
P.O. Box 7604
Ben Franklin Station
Washington, DC 20044
Future Guidance
Future guidance is expected related to donor-advised funds, including on some issues discussed in Notice 2017-73, such as:
- Treating certain distributions from donor-advised funds that pay for the purchase of tickets that enable a donor, donor-advisor, or related person to attend a charity-sponsored event as an excess benefit transaction
- Treating certain distributions from donor-advised funds that fulfill a pledge from a donor, donor-advisor, or related person as not being an excess benefit transaction
- How publicly supported charities treat contributions from donor-advised funds for their public support tests
We’re Here to Help
For more information on proposed regulations related to donor-advised funds, contact your Moss Adams professional.
Additional Resources