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IRS and Treasury Consider Proposed Regulations for Donor Advised Funds

By   Deb Nelson

January 11, 2018

Donor Advised Funds (DAFs) continue to be a popular charitable vehicle as an alternative to creating a private foundation. A DAF is a fund or account owned and controlled by a public charity (sponsoring organization), which is separately identified by reference to contributions of a donor(s), and with respect to which the donor(s) or donor advisor, has, or reasonably expects to have, advisory privileges with respect to the distribution or investment of the funds. Donors can take an immediate tax deduction for contributions to DAFs and then have advisory privileges over the distributions from the fund to charities in the future.

DAFs continue to draw interest and scrutiny from the Treasury Department and the IRS. The IRS released Notice 2017-73 in December, which provides insight on three key issues related to DAFs.  The notice provides interim guidance and solicits comments for the Treasury and the IRS to use in developing proposed regulations. Written comments on the issues raised in the notice may be submitted to the IRS by March 5, 2018.

More Than Incidental Benefit
Current regulations impose a 125 percent excise tax on a donor/advisor who recommends a distribution from a DAF that results in the donor/advisor or related person receiving more than incidental benefit.   In addition, if an individual at the sponsoring organization knew the recommended distribution would result in such a benefit, that individual is subject to a 10 percent excise tax. 

In 2006 and 2007, the Treasury and the IRS requested comments related to the operation and organization of DAFs.  Several comments were received that requested guidance on how certain distributions from an DAF should be handled. In response to those requests, the notice provides interim guidance that a distribution from a DAF to a section 501(c)(3) charity that enables a donor/advisor or related person to attend or participate in an event results in a more than incidental benefit and is subject to the excise tax. In general, “more than incidental benefit” results if the benefit received by the donor/advisor would have reduced or eliminated the charitable contribution deduction to the sponsoring organization. For example, a donor/advisor recommends a $10,000 distribution from a DAF to sponsor a table at a charity event. The non-charitable portion of the distribution is $3,000 (value of the meal, entertainment, etc.) Since the donor/advisor is receiving a benefit of $3,000 as a result of the distribution, the deduction would be reduced and this would be considered a “more than incidental benefit.”

In an effort to avoid this treatment, a practice has developed whereby the donor/advisor recommends the DAF distribute only the charitable portion and the donor/advisor pays the non-charitable portion personally. This is referred to as bifurcation. In this scenario, the notice states the charitable portion paid by the DAF is relieving the donor/advisor of the obligation to pay the full price and is still considered a direct benefit subject to the excise tax. This guidance also applies to membership fees.

Sponsoring organizations should review their current processes for fulfilling requests in which a benefit is received by the donor/advisor and also requests for bifurcated payments.

Satisfying Pledges
The notice provides clarification that a distribution from a DAF to a public charity to which a donor/advisor has made a charitable pledge will not result in a more than incidental benefit to the donor/advisor (for fulfilling the pledge) if the following requirements are met:

  • The sponsoring organization makes no reference to the existence of a charitable pledge when making the DAF distribution.
  • No donor/advisor receives any other benefit that is more than incidental.
  • A donor/advisor does not attempt to claim a charitable contribution deduction under Section 170(a) with respect to the DAF distribution, even if the distributee charity erroneously sends the donor/advisor a written acknowledgement in accordance with Section 1709(f)(8) with respect to the DAF distribution.

Sponsoring organizations will need to consider whether current processes require modifications to ensure no reference is made to a pledge of the donor/advisor. 

Avoiding ‘Public Support’ Limitations
When a charitable organization initially applies to the IRS for tax-exempt status under section 501(c)(3), it is presumed to be a private foundation unless it can satisfy requirements for public charity status. In order to obtain public charity status, and the benefits that go along with that, the organization needs to be able to show it is broadly supported by the general public, which involves passing a public support test. Refer to our previous article here for details on how the public support test calculation works. 

Many public charities under Section 170(b)(1)(A)(vi) normally receive a substantial part of their support from governmental agencies, public charities and the general public. Grants received from governmental agencies and other public charities under 170(b)(1)(A)(vi) are not limited in the calculation for public support. For example, if a grant of $50,000 is received from a public charity, the entire $50,000 is considered public support. However, if a grant of $50,000 is received from an individual donor, the amount that is considered public support is limited to 2 percent of the organization’s total support during the period. Currently, grants received from DAFs are considered to be from the sponsoring organization, which is a public charity, thus the entire amount is considered public support. However, this current position could allow an individual to use a DAF as an intermediary to avoid the 2 percent public support limitation. The IRS is proposing to “look-through” these types of grants and classify them for public support purposes as coming from the donor(s) of the DAF and thus subject to the 2 percent limitation.

The notice states the Treasury and the IRS are proposing that a donee organization, for purposes of determining its public support, must treat:

  • A sponsoring organization’s distribution from a DAF as coming from the donor(s) that funded the DAF rather than from the sponsoring organization.
  • All anonymous contributions received (including a DAF distribution for which the sponsoring organization fails to identify the donor that funded the DAF) as being made by one person.
  • Distributions from a sponsoring organization as public support without limitation only if the sponsoring organization specifies that the distribution is not from a DAF or states that no donor/advisor advised the distribution.

The proposed rule will require donee organizations to obtain detailed information from sponsoring organizations in order to identify the donors to the DAF from which the contribution was received. If a donee organization is unable to obtain detail on the donor (because the donor to the DAF wants to remain anonymous), it would need to limit the contribution, thus impacting its public support test. Specific comments have been requested in the notice for additional considerations relating to DAFs with multiple unrelated donors and for methods to streamline any required recordkeeping. 

Private Foundations
In addition to the three key issues discussed above, the Treasury and the IRS also requested comments with respect to how private foundations use DAFs in support of their purposes and whether a transfer of funds by a private foundation to a DAF should be treated as a “qualifying distribution” only if the DAF sponsoring organization agrees to distribute the funds for charitable purposes within a certain timeframe.

As outlined, the positions being taken by the Treasury and the IRS in the notice could have a significant impact on several stakeholders, such as donors/advisors, sponsoring organizations, donee organizations and private foundations. 

If you would like additional information or assistance in the drafting of comments related to the notice, please contact a member of our nonprofit team.