By Edward Yoder, CPA, MSA

In a significant development for the nonprofit sector, the IRS recently issued proposed regulations (REG-142338-07) concerning Donor Advised Funds (DAFs). These funds, which have become an integral part of charitable giving and nonprofit funding strategies, are likely to be subject to new guidelines that could reshape how they are managed and utilized. Understanding these changes is crucial for nonprofit organizations aiming to optimize their fundraising and donor engagement strategies.

Donor Advised Funds

Donor Advised Funds allow individuals, families, and entities to make charitable donations to a fund managed by a public charity. Contributors receive immediate tax benefits and retain rights to advise on the distribution and investment of their donations. These funds are managed by sponsoring organizations and have become popular due to their simplicity, strategic planning advantages, and potential for lasting philanthropic impact.

Background

Donor Advised Funds dates back to the 1930s, marking the start of a significant shift in charitable giving. The 1990s witnessed a surge in the visibility and popularity of DAFs. However, it wasn’t until the Pension Protection Act of 2006 that DAFs were formally recognized within the Internal Revenue Code. The regulations governing DAFs were subject to varied interpretations, leading to inconsistencies in their administration. The proposed regulations of 2023 aim to provide clearer guidelines, thereby standardizing the management and operation of DAFs.

Trends

In recent years, the growth of DAFs has been remarkable. In 2022, there were nearly 2 million DAF accounts in the United States, accounting for over 10 percent of all charitable giving in the nation. Grants from DAFs reached a new peak of $52.16 billion, a 9 percent increase, marking a consistent upward trend since 2009 and more than doubling in the past five years.

Key Changes in the Proposed Regulations

On November 13, 2023, the Department of the Treasury released the aforementioned set of proposed regulations for DAFs under IRC Section 4966. These regulations redefine critical concepts and set the stage for detailed future guidance, expanding the regulatory framework governing DAFs. Key changes include:

Definition of a Donor Advised Fund

The proposed regulations offer a detailed approach for identifying a Donor Advised Fund (DAF). They extend the criteria beyond formal documentation to encompass a variety of indicators, such as the fund’s financial activities (contributions, dividends, interest, distributions, expenses, and gains or losses) and the sponsoring organization’s practice of consulting with donors or donor-advisors before distributions. These factors can collectively help in determining whether a fund functions as a DAF.

 Donor

The proposed regulations define a “donor” as any person or entity that contributes to a fund at a sponsoring organization, with the specific exclusion of public charities and governmental entities. This distinction is important for understanding the legal and regulatory responsibilities associated with managing and contributing to DAFs.

Donor-Advisor

A donor-advisor plays a key role in guiding the charitable use of the funds within a DAF. They have been given the authority, either by the person who set up the Donor Advised Fund (DAF) or by another donor-advisor, to advise on how the funds should be distributed or invested. This means they can suggest which charities or causes the money from the DAF should go to, or how the money in the DAF should be invested before it’s given away. The proposed regulations specify that:

  • Establishment of Authority: The person doesn’t need a formal appointment or specific title to be a donor-advisor. As long as they are given the role of advising on the DAF’s distributions or investments, they are considered a donor-advisor.
  • Automatic Donor-Advisor Status: If someone sets up a DAF and advises on its assets, they are automatically a donor-advisor, regardless of whether they personally contributed to the fund.
  • Investment Advisors as Donor-Advisors: An investment advisor who manages both the DAF’s assets and the personal assets of a DAF donor is also considered a donor-advisor. However, if the investment advisor is working for the sponsoring organization as a whole, and not specifically for the DAF, they are not considered a donor-advisor.

Advisory Privileges

The criteria for determining advisory privileges have been broadened. This includes factors such as nonbinding recommendations by donors, written agreements, and the general solicitation of advice from donors or donor-advisors.

Excise Taxes and Taxable Distributions

The proposed regulations broaden the scope of liability for sponsoring organizations and fund managers by defining any approval action, not just the final decision, as a ‘knowing agreement’ to make a taxable distribution. This change emphasizes joint and several liability among fund managers, meaning each is individually responsible for the entire tax amount.

They also introduce an “anti-abuse” rule. This rule is designed to prevent the circumvention of the intended restrictions and tax liabilities associated with Donor Advised Funds (DAFs). Essentially, it targets arrangements or schemes that might be crafted to sidestep the rules governing taxable distributions from DAFs. By including this rule, the regulations aim to ensure that the operations of DAFs remain transparent and in alignment with the spirit of charitable giving and tax compliance.

Exceptions and Exclusions

New specific exceptions have been outlined, clarifying funds that do not fall under the DAF category. This includes funds making distributions only to a single identified organization, certain scholarship funds, and disaster relief funds.

 Effective Date

The IRS regulations on DAFs have been issued as proposed and are open for public comment.  Once the IRS issues the final regulations they will be effective for tax years beginning after the release of the final regulations.  The IRS has not indicated when the final regulations will be released.

Issues Awaiting Clarification

One significant area yet to be clarified is the establishment of payout requirements. Unlike private foundations, DAFs currently do not have a mandated minimum annual distribution, and the sector is awaiting guidance on whether such payout rules will be introduced.

Another critical area awaiting clarification concerns the rules governing successor advisors for DAFs, especially regarding the appointment process and the extent of their advisory powers. Additionally, the regulations have not yet addressed the handling of anonymous donations through DAFs, an area that intertwines donor privacy with legal compliance.

Furthermore, the extent of donor benefits remains ambiguous. Specifics about what incidental benefits donors can receive in return for contributions to DAFs, such as minor acknowledgments or event tickets, have yet to be outlined. These unresolved issues are crucial for understanding the operational scope and compliance requirements of DAFs, and their clarification will be pivotal in shaping charitable giving.

Implications for Nonprofit Organizations

The proposed regulations are set to have a profound impact on nonprofit organizations. Firstly, they may necessitate a reevaluation of fundraising strategies, particularly in how nonprofits engage with donors who prefer DAFs. Additionally, administrative processes may need to be updated to comply with the new definitions and exceptions.

In terms of long-term planning, not-for-profit organizations should consider how these changes might affect the flow of donations from DAFs. Understanding the nuances of these regulations will be key in maintaining and growing relationships with donors who use DAFs.

Preparing for the Changes

Nonprofit organizations can take proactive steps to adapt to these new regulations. This includes:

  • Educating fundraising and management teams about the changes.
  • Reviewing and possibly revising policies and procedures related to accepting donations from DAFs.
  • Consulting with tax experts or legal advisors to ensure full compliance and to understand the broader implications of the regulations.
  • Staying informed about the finalization of these regulations and any subsequent updates is also vital.

In the meantime, sponsoring organizations, donors, donor-advisors, and related persons may rely on the proposed regulations in interpreting and complying with IRC Section 4966, but are not required to do so; they may make other reasonable interpretations of IRC Section 4966 and take other reasonable positions until those proposed regulations are finalized, which is likely to happen before the end of year.

As the IRS refines the framework governing Donor Advised Funds, nonprofit organizations can stay ahead by remaining vigilant and adaptable. By understanding these proposed regulations and preparing for their implications, nonprofits can continue to effectively engage with donors and secure crucial funding in a changing philanthropic landscape.

If you have any questions about the Proposed Regulations or the DAF rules, contact Bo Garner or Ed Yoder, Leaders of PBMares’ Not-for-Profit group.