The Treasury Department and Internal Revenue Service are actively scrutinizing donor advised funds out of concern they may be generating questionable charitable deductions, impermissible economic benefits to donors, and management fees for promoters of such funds.
Donor advised funds have grown significantly over the years. The 2015 Donor Advised Fund Report from the National Philanthropic Trust states assets held in donor advised funds topped $70 billion in 2014, with distributions of $12.5 billion. Donor advised funds are popular because they generally have low start-up costs, donors receive an immediate charitable deduction; they are not subject to payout requirements, and they help instill a sense of philanthropy for future generations.
Donor advised funds are subject to some of the same operating restrictions of private foundations, which are intended to curb abuses. Sponsoring organizations of donor advised funds (community foundations, financial institutions, and other charitable foundations), donors, and recipient charitable organizations need to be aware of these prohibited actions to avoid disallowed charitable deductions, excise taxes, and revocation of tax-exempt status.
Transactions that result in a benefit to “insiders” of the fund may be subject to different tiers of penalty taxes, ranging from 25% to 200%. In all circumstances, the transaction must be corrected in addition to paying the penalty tax. Examples of transactions that can trigger taxes include providing the donor advisor of a donor advised fund with tickets to a special event upon receipt of a contribution from that fund, fulfilling a personal pledge through a donor advised fund, and making an impermissible distribution back to the donor or donor’s family member.
The IRS is conducting examinations of sponsoring organizations to ensure they are properly communicating with donors on who has ultimate authority of the funds, have internal policies and procedures ensuring permissible distributions from the funds, and have an appropriate overall fee structure. Typically the IRS starts by auditing the charitable organization that supports the DAFs, then as part of the audit they will request the specific financial information for each fund. The audit then will expand into individual transactions following each sale of property and each advised donation to determine if there is tax avoidance. These can be some of the most comprehensive and detailed IRS audits and can be very disruptive to the purposes of the charity and its efforts to raise contributions.
The IRS is also interested in the use of donor advised funds by private foundations. This concern surrounds making contributions to donor advised funds to meet the 5% payout requirement and to circumvent public support test issues related to public charities.
If you are a sponsoring organization or an organization who receives grants from donor advised funds, you should review your policies and procedures to ensure you have adequate steps to protect yourself and the donor from any economic benefit penalty taxes.