Donor Advised Funds Under Scrutiny

Take-Away: A Bill is pending before the U.S. Senate that would materially change the operations of a donor advised fund and private foundation with the goal to accelerate charitable distributions from donor advised funds and private foundations.

Background: Those familiar with philanthropy know just how popular the use of donor advised funds have become over the past decade. Sponsored by a publically supported charity [IRC 501(c)(3)], the contributions by a donor to a donor advised fund are immediately tax deductible as a charitable contribution, yet there is no corresponding obligation to immediately distribute the contribution to other charities from the fund. This practice has led some in Congress, notably Chuck Grassley, the Senator from Iowa, to believe that donor advise funds can be a form of tax abuse- claiming an immediate income tax charitable deduction, but conferring no immediate benefit on the community or public at large. [Senator Grassley was famous a couple of decades ago for stridently arguing that non-profit hospitals and universities should be subject income taxation in light of the amounts those non-profits paid to their executive employees.]

ACE Act: Senator Grassley is back again with his proposed Accelerating Charitable Efforts Act Bill, or the ACE Act. [Co-sponsor of the Bill is Senator King of Indiana.] The purpose of the ACE Act is to motivate distributions to charities within the community at a more rapid pace through the imposition of excise taxes and other forms of tax ‘relief.’ While the ACE Act also addresses private foundations, this missive will only summarize its impact on donor advised funds, or DAFs.

– Effective Date:  If enacted, the Bill would become effective after the date of its enactment.

– DAF Classifications: The Bill creates three new categories for donor advised funds: (1) a qualified donor advised fund; (2) a qualified community foundation donor advised fund; and (3) a non-qualified donor advised fund.

– Qualified Donor Advised Fund: As a gross generalization, if non-publically traded assets are contributed to this type of DAF, no charitable income tax deduction will be allowed for that contribution until the DAF actually sells the asset; the charitable income tax deduction will be limited to the gross sales proceeds that the DAF receives from the sale of the non-publically traded asset. In addition, a 50% excise tax will be imposed on the amount of that contribution and the earnings of the DAF if the contribution (and its earnings) is not distributed to charities within six (6) months after fourteen (14) years have passed since the contribution was initially made to the DAF.

– Qualified Community Foundation Donor Advised Fund: This is a DAF which either has advisory privileges over ‘other’ donor advised funds, with an aggregate value of at least $1.0 million (indexed for inflation), or the DAF requires qualifying distributions to equal at least 5% of the DAF’s value on the last day of the prior calendar year. If this is a ‘regional’ DAF, it can serve no more than a geographic area of four states. In addition, in no case can this DAF hold assets less than 25% of that IRC 501(c)(3) charity’s total assets outside of its DAF. Again, with regard to non-publically traded assets contributed to the DAF, there is no current income tax charitable deduction until the asset is sold by the DAF, and the charitable deduction is limited to the sales proceeds that the DAF receives on the sale of the non-publically traded asset.

– Non-Qualified Donor Advised Fund: The technical definition of this type of DAF is that it is neither a qualified donor advised fund nor a qualified community foundation donor advised fund. Like the other categories, no charitable income tax deduction is available for the contribution of non-publically traded assets to it until the sponsor makes a qualifying distribution of the sales proceeds, with the charitable deduction equal to the amount the DAF actually receives. In addition, no charitable income tax deduction is available to the donor until the DAF sponsor [the 501(c)(3) charity] actually makes a qualifying distribution; the donor’s charitable income tax deduction must equal the amount distributed by the DAF. If contributions are not currently distributed by the DAF, a 50% excise tax on the DAF is imposed six months after the 49th year after the initial contribution.

Reporting: The Bill also tightens up the reporting by the DAF to the donor. The contemporaneous written acknowledgement rules are expanded if non-publically traded assets are contributed to the DAF. That statement provided by the DAF must report the amount of gross sales proceeds it received on the sale of the asset and provide a clear statement to the donor that the donor cannot deduct an amount greater than the reported gross sales proceeds amount. In addition, the sales proceeds must be credited to the DAF within 30 days of the sale in order to be deductible by the donor.

Public Support ‘Test:’ The sponsor of a DAF, as noted, must be a publically supported charity described in IRC 501(c)(3). To meet that definition, a donor’s contribution to the charity cannot exceed 2% of its source of assets, so assure that the entity is, in fact, ‘publically supported.’ The 2% limitation on sources of support would be modified under the Bill so that all amounts from a single donor, to more than one donor advised fund, would be aggregated. Consequently, if one donor made multiple contributions to several different donor advised funds created by the same 501(c)(3) DAF sponsor, all of those different contributions would be aggregated as assigned to the single donor (despite several different DAFs, for purposes of determining if the 2% ‘test’ has been violated (which would then cause the sponsor to lose its tax exempt status.)

Conclusion: From the nature and scope of the proposed ACE Act, apparently there are a lot of abuses than I was aware of when it comes to obtaining charitable income tax deductions with contributions of non-publically traded asssets to donor advised funds. It will be interesting to see if the ACE Act becomes law this year or next year.