Senate Bill Proposes New Regulations for Donor-Advised Funds
Donor-advised funds (DAFs) have been around since the 1930s, but they’ve increased exponentially in number and value over the past few decades. Educational institutions, the philanthropic arms of financial services companies, and independent philanthropic organizations provide access to DAFs. Between 2016 and 2017, the number of DAFs grew by 60.2%, while grantmaking grew by 20%. There are around half a million DAFs in America, with an estimated worth of about $142 billion.
In June this year, Senators Angus King (I-ME) and Chuck Grassley (R-IA) introduced a new bill that would more tightly regulate the pace and transparency of distributions from DAFs. Titled the Accelerating Charitable Efforts Act, the legislation proposes several penalties and incentives that the authors say are needed to speed up distributions from DAFs to active charities.
What do donors need to know about DAFs right now and how the proposed legislation would change them?
Donor-Advised Funds (DAFs) versus Private Foundations
DAFs are private funds established by a donor at a public charity referred to as the “sponsoring organization.” Donors or their designees retain the ability to advise the sponsoring organization how to use the funds in the DAF, even though technically, the sponsoring organization controls the DAF. These advisory rights aren’t legally binding, but the sponsor seldom deviates from the donor’s recommendations in practice.
Unlike private foundations, DAFs are not separate tax-exempt entities. However, cash contributions to a DAF are generally deductible up to 60% of the donor’s adjusted gross income (AGI), while similar contributions to private foundations are only deductible up to 30% of the donor’s AGI. DAFs also do not incur the net investment income tax that private foundations do.
Currently, there’s no time limit to the DAF donor’s advisory privileges and no requirement for annual distributions from DAFs. In addition, DAFs are often specialized in dealing with non-cash assets like stocks and property. These assets can potentially appreciate for years in a DAF, but when they’re liquidated, donors do not have to pay capital gains tax.
In contrast, private foundations must make annual distributions of 5% of the total fair market value of their noncharitable-use assets from the preceding year to avoid excise taxes. Once a donor contributes to a foundation, the foundation decides how the money is distributed.
The Accelerating Charitable Efforts Act
If it passes, the Accelerating Charitable Efforts Act will limit the deductibility of specific contributions to DAFs and will tax portions of some contributions if they are not distributed within specified timeframes. Based on factors like their geographical focus and the duration of advisory privileges, DAFs will be categorized as one of the following:
1. Qualified DAFs
2. Qualified Community Foundation DAFs
3. Nonqualified DAFs
Contributions to non-qualified DAFs can remain undistributed for up to 50 years, but will only be tax-deductible when distributed. However, donors can still save on capital gains and estate taxes by putting their assets in a DAF. For qualified DAFs, donors will receive an immediate tax deduction if they agree to give to a charity within 15 years. Under certain conditions, an excise tax equivalent to 50% of any non-distributed contribution will be imposed.
The Act will exempt limited duration foundations and those making distributions of more than 7% from the current annual 1.39% excise tax. But it will restrict what qualifies as a distribution for private foundations — specifically disallowing distributions to DAFs and expenses paid to disqualified people of the foundation (with certain exceptions).
The legislation will also limit when a public charity may treat support from a DAF as “public support.” The Internal Revenue Code requires public charities to receive minimum levels of support from the general public. The specifics vary depending on what sections of the Code a particular charity falls under.
Currently, all donations from DAFs to public charities are regarded as support from the general public. This effectively allows DAFs to be used for anonymous donations, because the organization sponsoring the DAF is not required to disclose the source. But if the Act passes and the original donor isn’t disclosed, a gift from a DAF won’t count as public support. If the donor is disclosed, the support will be treated as though coming directly from that donor.
When Will the Provisions of the Act Be Effective?
If the bill is passed and signed into law, the provisions would be effective on enactment. Sponsoring organizations, private foundations, and public charities would need to conform to the new legislation for tax years beginning after December 31, 2021.
Today, one in every eight charitable dollars is estimated to be directed to a DAF. Yet much of this money remains undistributed. For example, a Council of Michigan Foundations report showed that more than one-third of DAFs sponsored by community foundations in the state distributed nothing in 2020.
Opponents of the bill point out that payout rates for DAFs exceed the 5% minimum required of private foundations, averaging as much as 20% annually. Others argue the bill would place unnecessary financial burdens on community foundations by forcing them to track every donation.
What is clear is that this bill will be hotly debated in Congress and the philanthropic community. Donors, foundations, and the public should pay attention to the developing conversation around the Accelerating Charitable Efforts Act this fall.