The first donor-advised funds appeared back in the 1930s but were not formally recognized in the Internal Revenue Code until the Pension and Protection Act of 2006. Today, these funds are one of the fastest-growing vehicles for making current charitable contributions but are also being incorporated in many tax planning strategies. Exactly, what are donor-advised funds?

A donor-advised fund (DAF) is a separately identified and managed charitable investment account that is operated by a Sec. 501(c)(3) organization, also known as a sponsor or sponsoring organization. Often these sponsoring organizations are affiliated with brokerage houses and community foundations, but more recently with hospitals, universities, charities associated with affiliated corporations and religious institutions. Increasingly more DAFs are being used to facilitate workplace giving and online fundraising. Recent reports indicate that more than 1000 DAFs exist.

How does a DAF operate? Many times, donors have never heard about a DAF before this donation strategy is recommended by an accountant, attorney, tax planner or investment manager. Generally, the donor makes what will become a charitable donation to an existing DAF. The donor benefits by enjoying an immediate tax benefit for the contribution. That contribution is 100% irrevocable and is ultimately destined for distribution to a 501c3 organization, including a foreign equivalent of a 501c3. The final distributions to a grantee are not necessarily immediate, or even in the same tax year, hence the ongoing controversy surrounding DAF giving. Once received, the sponsoring organization has legal control over those funds. The donor retains advisory rights with respect to the investment of those funds and the ultimate distribution of those funds. At some point after the original donation, the donor or the donor’s representative, recommends that the sponsor donates to a public charity. The sponsor is not legally bound to the donor’s request and will usually perform due diligence to verify the grantee’s tax-exempt status and may reject the donor’s request. The great end result, the charity gets its donation.

The donor would be wise to research DAFs before randomly selecting one. Some of the factors to consider:

• Is there a minimum initial contribution?
• Are there minimums for additional contributions?
• What assets will the DAF accept? Cash, stocks, bonds, IRA and 401k funds, cryptocurrencies, life insurance, real property?
• What investment options are available for the account?
• Is there a minimum amount for grants to charities?
• How often can grants be recommended by the donor?
• How much are the annual admin fees, investment fees and maintenance fees? DAFs make money from these fees.
• What is the reporting, performance and governance of the DAF?

Many donors are seeking local impact, so they might be more interested in a community DAF as opposed to a larger sponsoring organization. Some sponsors offer customizable DAFs based on the donor’s impact, geographic and investment preferences.

Donors can make contributions in a variety of ways including induvial giving, supporting charitable special events, creating private foundations or opening a DAF fund, to name a few.

What are the advantages DAF fund donors enjoy:

• DAF funds are relatively simple and cheaper to establish.
• DAF giving works for all levels of wealth.
• Administrative work shifts from the donor to the DAF sponsor.
• Donors may retain investment decisions or allow fund managers to make these decisions.
• Charitable donations can be bundled for tax purposes into one year, while outgoing grants can be spread over time.
• Many sponsoring organizations allow the donor to name a successor of the DAF if the donor should become incapacitated or pass away.
• Multiple donors can contribute to the DAF. Think about bequest and memorial type contributions.
• Allows a donor to reach international charities and other non-governmental organizations while still receiving a federal tax credit.
• Helps a donor create a philanthropic vision, philosophy and legacy.
• Allows for the more beneficial tax treatment of contribution as opposed to donating to a private foundation and finally,
• Protects the privacy of donors, by allowing the individual donors and grants to be kept private.

So, what are some of the disadvantages?

• The contributions to the DAF are irrevocable.
• The donor gives up full control over the funds and relies on the sponsor to approve their recommendations.
• Investment options and contribution amounts might be limited by the sponsor.
• DAF participants cannot receive any personal benefit from a grant request, such as tickets to a charity gala.

The controversy and what to watch for your future giving

The great debate about donor-advised funds is centered around the fact that DAF sponsoring organizations are not getting funds out fast enough to the charities. Not that the DAFs are inefficient, but that there is no required distribution amount or percentage for a DAF like there is for a private foundation.

Introduced in July 2021 a Senate bill, proposes to influence the deductibility of charitable contributions if not disbursed within certain time frames like 15 or 50 years. Under current law, assets can remain in a DAF indefinitely, tax-free. There are great debates on both sides of this discussion, including the impact on sponsoring organizations as well as charitable recipients. In February 2022, the House introduced its version of the legislation on this issue calling the “Accelerating Charitable Efforts Act” the “ACE Act” The House version, which almost mirrors the Senate bill, would place additional restrictions on the deductions for contributions to DAFs, establishes minimum payouts and establishes failure to payout taxes.

No matter, where you fall on this great debate, if you are a DAF donor or a charity recipient of DAF donations, new legislation will impact those contributions.

If you have any questions regarding DAFs, please reach out to an HBK Tax Adviser.

On Thursday, May 28^th, HBK and Gannon University SBDC presented the second installment of their “From Survive to Thrive” webinar series. In this session, Amy Dalen, JD, Chair of the HBK Tax Advisory Group, and Ben DiGirolamo, CPA, JD, provided a tax update for individuals and businesses. Below are some of the highlights from this session. Economic Impact Payments Amy provided an update on the Coronavirus Aid, Relief, and Economic Security (CARES) Act economic impact payments, indicating that a number of payments have been paid incorrectly to deceased individuals and individuals who have been incarcerated. The Internal Revenue Service (IRS) recently released Frequently Asked Questions (FAQs) providing information on how these payments can be repaid. While FAQs can provide us with valuable insight into the positions that the IRS is likely to take, if they are not otherwise published they should not be relied upon as authoritative. Amy pointed out that some of the FAQs provided by the IRS are more restrictive than the statutory language of the CARES Act. Retirement Planning Amy went through a summary of the CARES Act benefits provided for retirement plans, including a waiver of the 10% penalty for early withdrawals up to $100,000 for qualified individuals, and the increase to permissible loan amounts from $50,000 to $100,000. A qualified individual has either been diagnosed with coronavirus, had a spouse or dependent diagnosed with coronavirus, or been financially impacted by coronavirus. Qualified distributions can be recognized as income over a three year period, and can also be repaid to the plan during that time. The IRS is expected to issue additional guidance, and has indicated that the guidance provided will be similar to the guidance issued for distributions allowed in the wake of Hurricane Katrina. In the mean time, the IRS has provided FAQs. Charitable Contributions Amy pointed out that charities have been suffering from a decrease to charitable contributions in the wake of the Tax Cuts and Jobs Act (TCJA) of 2017, which increased the standard deduction and eliminated the charitable deduction benefit for many taxpayers. The CARES Act attempts to address this by making a permanent $300 charitable deduction for individuals that use the standard deduction, which will be an above-the-line deduction. Contributions must be in cash in order to qualify for this deduction. In addition, the CARES Act increased the adjusted gross income (AGI) limitation for cash contributions to certain 501(c)(3) organizations from 60% to 100% for tax year 2020, and increased the corporate charitable deduction limitation to 25%. Contributions in excess of these limits can be carried forward for up to five years. Excess Business Loss Limitation Amy explained that the TCJA created a new limitation for non-corporate taxpayers on business losses that exceed $250,000 for single filers and $500,000 for married filers that file a joint return. The CARES Act eliminates this limitation completely for farm losses, and suspends the limitation for non-corporate taxpayers for tax years 2018 through 2021. This provides an opportunity for taxpayers to amend their 2018 returns and use business losses that were limited. In addition, the CARES Act provided some technical corrections, clarifying that W-2 wages are not considered business income for purposes of the excess business loss calculation, and that capital gains included in the calculation are limited to a taxpayer’s net capital gain. Individual Planning Opportunities Amy pointed out that low interest rates and low market values are providing significant opportunities for taxpayers. Some of these opportunities include Roth IRA conversions, the use of Grantor Retained Annuity Trusts (GRATs) and other estate “freeze” techniques, and the use of related party loans. For any related party loans currently in existence, taxpayers should consider revising them to take advantage of the low AFR rates. Deductibility of PPP Loan Expenses Ben began his presentation covering one negative provision that came out of the CARES Act: the inability of businesses to deduct expenses that are paid for by PPP loan proceeds that are later forgiven. The CARES Act provides that the loan forgiveness is not taxable income, and the IRS is taking the position that any expenses related to that loan forgiveness are not deductible. This leaves businesses in the same boat as if the forgiven amount were taxable and the expenses were deductible. Ben pointed out that Congress may change this position to make the expenses deductible even though the loan is forgiven. Employee Retention Tax Credit Ben covered the new employee retention credit that was put in place by the CARES Act, indicating that it may be taken if a business was fully or partially suspended during a quarter in 2020 due to a government order, or if gross receipts were less than half of those from the same quarter in 2019. Ben pointed out that businesses that have received a PPP loan are not entitled to the credit. The credit is against the employer’s 6.2% share of Social Security payroll taxes, and is equal to fifty (50) percent of a) wages up to $10,000 per employee paid to the employees unable to work because of COVID-19 if the business had more than 100 employees in 2019, and b) all wages up to $10,000 per employee for businesses with less than 100 employees. The employer is allowed to reduce their otherwise required payroll tax deposits by the credit amount, and can file and get a cash refund if the credit exceeds the deposit. Employer Payroll Tax Deferral Ben went over the payroll tax deferral, which allows employers to delay payment of their side of the Social Security tax for deposits made from March 27^th through the end of the 2020 calendar year. Fifty (50) percent of the deferred amount will be due at the end of 2021, and the other half will be due by December 31, 2022. Employers are allowed to delay payments until they receive notice from the SBA that any portion of their PPP loan is forgiven. This deferral also applies to fifty (50) percent of self-employment taxes. Net Operating Losses Ben explained that the net operating loss carryback period was extended, which makes a change to the prior elimination of the two-year carryback period by the TCJA. Taxpayers are now allowed a five-year carryback period for 2018, 2019, and 2020 tax years, and the 80 percent limitation that was imposed by the TCJA has also been eliminated for carryforwards. Business Interest Expense Limitations Ben explained that the TCJA provided for a thirty (30) percent adjusted taxable income limitation on the deductibility of interest expense for businesses with $26 million or more in average annual gross receipts. The CARES Act increased this limit to fifty (50) percent for tax years 2019 and 2020, though partnerships are only allowed the increase in 2020. Qualified Improvement Property Ben provided a quick overview of a technical error found in the TCJA which required qualified improvement property (QIP) to have a 39-year life and not qualify for bonus depreciation, which was not the intention of Congress. The CARES Act reduced the life to 15 years and provided that it is eligible for 100 percent bonus depreciation. QIP applies to anything internal, non-structural, and after initial construction. The technical correction is retroactive to 2018 and can be applied using amended returns or by filing an accounting method change. Accelerating Disaster Losses Ben provided an overview of a potential benefit to businesses. When there is a federally declared disaster, businesses may be able to deduct certain financial losses as casualty losses, and may be able to accelerate those losses to the tax year preceding the year of the loss. Since the current situation related to COVID-19 is a federally declared disaster, businesses may be able to accelerate deductions for abandoned leaseholds, capitalized costs from abandoned business deals, contract termination payments, and unrefunded prepaid expenses in to the 2019 tax year. Qualified Disaster Relief Payments Finally, Ben pointed out that employers are able to make tax-free payments to employees during a federally declared disaster in order to reimburse them for certain expenses. These payments are still deductible by the employer. Expenses that employers may be able to reimburse include medical expenses not covered by insurance, medicine and sanitizers, costs to work from home, and childcare. The exclusion does not apply for ordinary wage payments.

People support charitable organizations for philanthropic reasons. But they are also motivated by the tax deduction afforded by the U.S. Tax Code. To substantiate a donation and take the related deduction, a donor is required by the IRS to acquire and keep “contemporaneous written acknowledgement” from the charitable organization. Depending on the amount and type of donation, the required documentation comes in various forms. Practically speaking, charitable organizations are responsible for knowing what type of information must be provided to their donors, though the onus is on the donor to keep the documentation and meet any other recordkeeping requirements.

Generally, contemporaneous written acknowledgement issued by the charitable organization must include the following, as applicable:

• The amount of cash donated
• A description of any non-cash property donated
• A statement and good faith estimate of the value of any goods or services related to the donation of cash or property (if the donor received more than a de minimis item—that is, an amount too small to merit consideration)
• Acknowledgement if the organization provided intangible religious benefits
• A description of out-of-pocket expenses incurred by the donor and whether the donor received goods or services in exchange for out-of-pocket expenses

The organization must provide the written acknowledgment when it receives a single donation of $250 or more from a donor. It can be provided at the time of the gift, or once for the entire tax year. The organization is not required to acknowledge separate donations of less than $250 each, even if they total more than $250 for a tax year. However, charitable organizations often send an annual statement to donors reporting their total donation for the year, regardless of the amount.

The IRS does not require organizations to follow a prescribed format for the written acknowledgment. It can be paper-based, such as a statement, letter or postcard, or electronic. To qualify as contemporaneous, a written acknowledgment must be received by a donor before the earlier of the date the donor files their original federal tax return for the year the contribution was made, or the due date, including extensions, for filing their tax return for that year.

In addition to documentation obtained from a donee organization, a donor is also required to maintain written records that include the following:

• Name and address of the organization
• Date and location of the contribution
• Description of the property
• Fair market value of the property (or cost, if elected)
• Details regarding contributions of partial interests of property, if applicable
• The terms of any conditions associated with the contribution
• For separate contributions of $500 or more, details of how and when the property was acquired and the property’s cost or basis (Cost basis is not required for donations of publicly traded securities.)
• For separate contributions of $5,000 or more, a qualified appraisal to be obtained and attached to the income tax return

There are also other forms and documentation required for donations of property, such as artwork, securities, vehicles or inventory. Click here to view the chart that summarizes the IRS’s rules for substantiation and documentation.

Donors typically expect to maximize their tax deductions for charitable contributions. Proper documentation is the primary requirement established by the IRS to take the deductions. Organizations can help their donors satisfy this requirement by ensuring they issue the proper acknowledgment.

Organizations or donors with questions about the documentation or substantiation requirements can contact an HBK tax advisor.