On November 14, 2023, the IRS proposed regulations providing guidance on certain rules regarding donor advised funds (DAFs). These proposed regulations shed further light on the definition of DAFs and taxable expenditures. Here, we break down key concepts for understanding DAFs and other advisory privileges.
What Is a DAF?
Generally, a DAF is a separately identified fund or account that is maintained and operated by a 501(c)(3) organization (the sponsoring organization) in which the donor, or the donor’s representative, retains advisory privileges for the distribution of funds and the investment of assets in the account.
The proposed regulations take an extremely broad view of this definition. They state that a fund is “separately identified by reference to contribution of a donor or donors” if formal records of funder contributions are maintained by the sponsoring organization. Prior to these proposed regulations, the fund was not treated as a DAF if there was no reference to the donor’s identity on the account, even if there were advisory privileges.
Lack of formal records will not necessarily disqualify a fund from being a DAF. The facts and circumstances test would apply. Some key facts used to determine whether a fund is considered separately identified include:
- The fund or account balance reflects items such as contributions, dividends, interest, distributions, administrative expenses, and gains and losses (realized or unrealized).
- The fund or account is named after one or more donors, donor-advisors, or related persons.
- The sponsoring organization refers to the fund or account as a DAF.
- The sponsoring organization has an agreement or understanding with one or more donors or donor-advisors that the fund or account is a DAF.
- One or more donors or donor-advisors regularly receive a fund or account statement from the sponsoring organization.
- The sponsoring organization generally solicits advice from the donors or donor-advisors before it makes distributions from the fund or account.
What Are Advisory Privileges?
The proposed regulations expand the concept of advisory privileges. Any factors listed below are sufficient to establish advisory privileges:
- The supporting organization allows the donors or donor-advisors to provide nonbinding recommendations regarding the distribution or investment of DAF assets.
- There is a written agreement stating that donors or donor-advisors have such advisory privileges.
- A written document or marketing material of the sponsoring organization indicates that donors may provide such advice.
- The sponsoring organization generally solicits such advice from donors or donor-advisors.
Who Is Considered a Donor or Donor-Advisor?
The proposed regulations define a donor as a person or entity that contributes to a fund or account of a sponsoring organization. This definition excludes public charities (other than disqualified supporting organizations) and governmental units. Private foundations are included in the definition of a donor.
A donor-advisor is defined in the proposed regulations as any person appointed or designated by a donor to have advisory privileges regarding the distribution or investment of assets held in a fund of a DAF. If a donor-advisor further delegates advisor privileges to another person, that person will also become a donor-advisor.
The proposed regulations have extended the definition of donor-advisor to include:
- Investment advisors advise on the funds held in a DAF and advise on personal non-DAF assets of a donor-advisor. If the investment advisor provides services to the entire DAF, rather than a specific fund, the investment advisor is excluded from the definition of donor-advisor.
- Any person (other than a public charity or governmental unit) that establishes the fund and has advisory rights, irrespective that they did not contribute to the fund.
- An advisory committee member that advises as to distributions or investments of amounts in the fund or account unless certain requirements are met.
Often, a donor wants a holistic approach when managing their investments and the donor may request the same investment manager to manage their personal investment assets, investment assets of their private foundation, and the investment assets held in their DAF account. Suppose the sponsoring organization agrees on the donor’s recommendation to hire the investment manager who manages the donor’s other entity assets, an excise tax will be imposed on the investment manager and the sponsoring organization unless the investment manager advises on the entire assets of a sponsoring organization.
This broader definition of advisory privileges can create more funds at community foundations (including field of interest funds or memorial funds) or “friends of” funds that can be treated as DAFs. If community foundations or friends of funds are considered DAFs, they would be limited in their ability to make grants to individuals, which many of these funds do since a DAF cannot make a distribution to an individual.
The proposed regulations do allow DAFs to distribute certain scholarship and disaster relief funds to individuals.
What Is a Taxable Distribution?
A taxable distribution under IRC Section 4966 means any distribution from a DAF (i) to any natural person or (ii) to any other person, if the distribution is for any purpose other than charitable purposes (as described in IRC §170(C)(2)(B)) or if the sponsoring organization does not exercise “expenditure responsibility” in accordance with IRC §4945(h).
The proposed regulations expand the statutory definition of a distribution (which includes any grant, payment, disbursement, or other transfer from a DAF) by introducing the concept of a deemed distribution. A deemed distribution is any use of DAF assets resulting in more than an incidental benefit (within the meaning of IRC §4967) to a donor, donor-advisor, or a related person, as well as any expense charged solely to a DAF that is paid directly or indirectly to a donor, donor-advisor, or related person with respect to the DAF.
Certain distributions paid from a DAF including, but not limited to, investments, reasonable grant-related expenses, or investment fees generally will not be treated as distributions unless they are deemed distributions, e.g., they provide more than an incidental benefit to donors, donor-advisors, or related persons.
What Are the New Anti-Abuse Rules?
The new anti-abuse rules state that if a series of distributions, under the proposed regulations, stepped together, would create a taxable distribution as the end result, then the distributions would be treated as a single distribution for purposes of §4966. For example, suppose a sponsoring organization complies with the recommendation of a donor or donor-advisor to make a distribution to a public charity. The donor then arranges for the public charity to make distributions to individuals recommended by the donor. Then, the initial DAF distribution will be considered a taxable distribution from the sponsoring organization to individuals.
Who Pays the Tax?
The proposed regulations cast a wide net on who will be exposed to potential excise taxes. Below is a summary of who will be potentially exposed and under which code section.
- §4958 Excess benefit transactions
- §4958 imposes a 25% excise tax on the excess benefit, payable by the disqualified person with respect to the transaction.
- A separate 10% excise tax on the excess benefit is paid by organization managers if the participation of any organization manager is in the transaction (knowing that it is an excess benefit transaction) unless such participation is not willful and is due to reasonable cause.
- §4966 Excise tax on taxable distributions
- §4966(a)(1) imposes a 20% excise tax on each taxable distribution, payable by the sponsoring organization with respect to the DAF.
- §4966(a)(2) imposes a 5% excise tax on the agreement of a fund manager to the making of a taxable distribution knowing that it is a taxable distribution, payable by any fund manager who agreed to the making of the distribution.
- §4967 Excise tax on paid professional advisors
- §4967(a)(1) imposes a 125% excise tax on the tax imposed shall be paid by any person who advises as to the distribution or who receives such a benefit as a result of the distribution.
- §4967(a)(2) imposes a 10% excise tax on the agreement of a fund manager to the making of a distribution, knowing that such distribution would confer a benefit of the amount of such benefit. The tax imposed shall be paid by any fund manager who agreed to the making of the distribution.
The November 14, 2023 proposed regulations are only the first installment planned for DAFs. They continue to be included in the IRS Priority Guidance Plan. In addition, there has been proposed legislation, e.g., the Accelerating Charitable Efforts (ACE) Act of 2022, and other efforts to address concerns that these funds are not distributed to charities on a timely basis.
If you have questions regarding donor-advised funds or need assistance, please reach out to a professional at FORVIS.