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.