Overview
The Department of Treasury (Treasury) and the Internal Revenue Service (IRS) released proposed regulations governing taxes on taxable distributions from Donor Advised Funds (DAFs) under section 4966[1](the “proposed regulations”). The Code defines a DAF as a fund or account (1) that is separately identified by reference to contributions of a donor or donors, (2) that is owned and controlled by a sponsoring organization, and (3) to which a donor (or donor-advisor) has, or reasonably expects to have, advisory privileges over either distributions or investments of amounts held in the fund by reason of the donor’s status as a donor. Generally, section 4966 imposes an excise tax when a distribution from a DAF is made to a natural person, toward a non-charitable purpose, or in cases in which the sponsoring organization does not meet its obligation to exercise expenditure responsibility. Section 4967 also imposes a tax in cases in which on the advice of a donor or donor advisor, a distribution is made from a DAF that directly or indirectly confers a more than incidental benefit on the donor or donor advisor, or persons (including 35% controlled entities) related to the donor or donor advisor.
DAFs are becoming increasingly popular because they provide numerous benefits that are attractive to donors. Specifically, donations to a DAF permit donors to take charitable contributions, estate and gift tax deductions, and advise on the distribution of charitable assets, and DAFs have less administrative burdens than private foundations. The proposed regulations provide definitions to clarify certain defined terms in the statutes and provide specific guidance as described in this article, but there are still statutory provisions that have not been addressed by these provisions and will most likely be addressed in additional regulations in the future.
Primary Definitions
- DAF: The proposed regulations adopt the definition of DAF in the statute, as written, but clarify that the second requirement, that the fund or account is “separately identified by reference to contributions of a donor or donors, is satisfied if the sponsoring organization maintains a formal record of contributions to the fund or account relating to a donor or donors.” According to the proposed regulations, this would include the sponsoring organization tracking donor contributions. Absent formal tracking, a facts and circumstances test would govern whether the second requirement is satisfied.
- Donor: Although the definition of donor is broadly defined to mean any person described in section 7701(a)(1)[2], the proposed regulations, at the suggestion of commentators, exclude from the definition (1) public charities, except for certain supporting organizations, and (2) any governmental unit.
- Distribution: The proposed regulations define distribution broadly to mean any grant, payment, disbursement, or transfer, whether in cash or in kind, from a DAF. Excepted from this definition, however, are investments and reasonable investment and grant-related fees unless they result in a more than incidental benefit to a donor, donor-advisor, or related person.
Specific Guidance
- Advisory Privileges: To determine whether a donor has, or reasonably expects to have, advisory privileges, as is required for a fund or account to be a DAF, the proposed regulations propose a facts and circumstances test, and the advisory privilege condition will be satisfied if one of four facts is present: the donor (or donor advisor) (1) may make nonbinding recommendations regarding distributions or investments, (2) is given advisory privileges in a written agreement, (3) is given advisory privileges through a written document or marketing material of the sponsoring organization indicating as such or (4) is solicited for advice from the sponsoring organization regarding the distribution or investments.
- Donor-Advisor: Donor advisors generally include a person suggested or recommended by a donor to have advisory privileges. The proposed regulations provide that an investment advisor is considered a donor advisor if they manage the investment of both the assets maintained in a donor advised fund and the personal assets of a donor to that donor advised fund. However, an investment advisor providing services to the sponsoring organization as a whole, as opposed to a specific DAF would be excepted from this provision. There is also an exception for a person who is recommended by the donor to serve on an advisory committee of the sponsoring organization if the recommendation is based on objective criteria related to the individual’s expertise or the purpose of the fund or account, there are at least three individuals on the committee and a majority of the committee is not recommended by the donor, and any recommended individuals are not related to the donor or donor-advisor.
- Multiple Donor Funds: Although the proposed regulations do not have an automatic exemption for DAFs that have multiple donors, the proposed regulations do allow for certain exceptions if a donor or donor-advisor has no expectation of advisory privileges. Furthermore, the proposed regulations provide other exceptions for funds or accounts for which advisory-privilege is held by donors who are public charities or governmental units and funds or accounts over which advice is provided by a committee consisting of one or more donors, donor-advisors, related persons, or recommended persons.
- Exceptions: The proposed regulations expand on the statutory exceptions for a DAF for entities where distributions are provided solely to a single identified organization and certain scholarship funds to include exceptions for (1) scholarship funds established by a broad-based membership organization under section 501(c)(4) if enumerated conditions are met, and (2) disaster relief funds that meet certain conditions. The regulations do not include any other exceptions for funds with a single identified charitable purpose.
Initial Implications
- Sponsoring organizations will need to determine whether certain funds that may have been treated as field-of-interest funds fall into the definition of a DAF and whether the use of advisory committees or other exceptions are applicable.
- DAFs that are currently purchasing goods or services directly would need to conduct expenditure responsibility on these distributions or distribute the funds to the sponsoring organization first, so that they are not considered taxable distributions.
- Outside investment advisors may be prevented from being compensated from donor advised funds if they also advise on the donor’s personal assets.
Treasury and the IRS have requested comments on the proposed regulations, which are due 60 days after the proposed regulations are published in the Federal Register.
Endnotes
[1] Unless otherwise indicated, references to a “section” are to a section of the Internal Revenue Code of 1986, as amended (the “Code”) and all “Treas. Reg. §” references are to the Treasury regulations promulgated thereunder.
[2] Section 7701(a)(1) defines “person” to mean and include an individual, a trust, estate, partnership, association, company or corporation.