Endowment Donor Advised Funds-Stay Away

Take-Away: Since the Tax Code does not contemplate an ‘endowed’ donor advised fund, there is a risk that a donor will be denied a charitable income tax deduction with respect to contributions made to the ‘endowed’ donor advised fund.

Background: Some donor advised funds (DAFs) are currently being publicly marketed as ‘endowed’ DAFs. Is it even possible for a DAF to be subject to distribution restrictions, other than the immediate right of distribution held by the DAF’s sponsoring public charity? An endowment DAF is highly doubtful.

DAFs: The Tax Code defines a donor advised fund (DAF) as follows:

• “In General: Except as provided in subparagraphs (B) or (C) the term ‘donor advised fund’ means a fund or account: (i) which is separately identified by reference to contributions of a donor or donors; and (ii) which is owned and controlled by a sponsoring organization; and (iii) with respect to which a donor (or any person appointed or designated by such donor) has, or reasonably expects to have, advisory privileges with respect to the distribution or investment amounts held in such fund or account by reason of the donor’s status as a donor.
• Exceptions: The term ‘donor advised fund’ shall not include any fund or account- (i) which makes distributions only to a single identified organization or governmental entity; or (ii) with respect to which a person described in subparagraph (A)(iii) advises as to which individuals receive grants for travel, study, or other similar purposes if:
• Such person’s advisory privileges are performed exclusively by such person in the person’s capacity as a member of a committee all of the members of which are appointed by the sponsoring organization;
• No combination of persons described in subparagraph (A)(iii) (or persons related to such persons) control, directly or indirectly, such committee, and
• All grants from such fund or account are awarded on an objective and nondiscriminatory basis pursuant to a procedure approved in advance by the board of directors of the sponsoring organization, and such procedure is designed to ensure that all such grants meet the requirements of paragraph (1), (2) or (3) of IRC 4945(g).” [IRC 4966(d)(2).]

The 2006 Legislative History of the Pension Protection Act of 2006, which added the ‘owned and controlled’ requirement to the statutory definition of a DAF, commented on the limit of how a DAF is administered and distributions made:

“Although sponsoring charities frequently permit donors (or other persons appointed by donors) to provide nonbinding recommendations concerning the distribution or investment of assets in a donor advised fund, sponsoring charities generally must have legal ownership and control of such assets following the contribution. If the sponsoring charity does not have such control (or permits a donor to exercise control over the amounts contributed), the donor’s contribution may not qualify for a charitable deduction, and, in the case of a community foundation, the contribution may be treated as being subject to a material restriction or condition by the donor.” [Emphasis added.]

Conclusion: From the Legislative History, it thus is clear that the decision to endow a DAF account cannot come from the DAF donor without the DAF being void. If a sponsoring organization even offers a donor an endowment option for his/her DAF, it is also possible that the IRS could construe the DAF sponsor’s concurrence in that decision as a material restriction or condition imposed by the donor. In short, if a DAF is to be ‘endowed,’ that decision must be solely that of the DAF sponsor, not the donor. If that is not the case, then the donor will be denied a charitable income tax deduction associated with their contribution to their DAF. It would be wise for a donor to stay away from an ‘endowed’ DAF, since it might attract the attention of the IRS leading to a loss of a tax deduction.