The ABCs of Donor Advised Funds

Donor Advised Funds Gain in Popularity—and Draw the Eye of Congress

by Philip R. Lieberman, CPA

California CPA magazine: June 2007

Donor advised funds (DAFs) provide wonderful flexibility for individuals and multiple generations of families. They are offered by sponsoring charities, as a service to donors, to encourage the creation and operation of grant making funds within the legal control and structures of the sponsoring charity.

DAFs are maintained by Sec. 501(c)(3) public charities, and gifts are typically deductible to the 50 percent of adjusted gross income for cash and 30 percent of adjusted gross income for appreciated property limits for public charities.

In exchange for a tax-deductible gift, most often in the form of cash, the sponsoring charity grants the donor the right to make non-binding recommendations about how the funds should be used and distributed for charitable purposes. A donor may advise, suggest or recommend grants made by the fund over time, but the donor isn’t technically allowed to direct gifts.

As an indication of their growth, total assets in DAFs held at 88 organizations increased to $15.5 billion in 2005 from $12.7 billion in 2004, according to The Chronicle of Philanthropy. And in 2005, DAFs distributed more than $3 billion to charities.

Despite these benefits, there are some areas of concern that have drawn the attention of Congress in recent years.

New Rules and Regulations

Prior to the Pension Protection Act of 2006 there was no statutory regulation of DAFs. The bill, for the first time, provides such regulation by imposing rules with respect to whom distributions may be made from a DAF and corresponding penalties for distributions to nonqualifying organizations and individuals; enacts new rules regarding substantiation of gifts to DAFs; and applies the excess benefit transaction rules and excess benefit holdings rules to DAFs.

Recently, DAFs have come under scrutiny by the IRS, prompted by concerns that donors may have used the funds as tax-free slush funds, including using the donations for personal expenses like tickets or tuition.

Congress has shown concern as to whether or not contributions to DAFs should qualify for charitable contribution deductions. The PPA demonstrated this when it excluded gifts to DAFs from the bill’s provision allowing individuals age 70.5 and older to make outright charitable contributions of up to $100,000 in 2006 and 2007 in tax-free rollovers from IRAs.

DAFs Defined

The PPA defines a DAF as a fund or account that is separately identified by reference to contributions of a donor or donors, is owned and controlled by a charitable sponsoring organization, and to which a donor (or any person appointed or designated by the donor) has advisory privileges with respect to the distribution or investment of amounts in the fund. If any one of these characteristics is absent, the fund is not a DAF.

In addition, with respect to contributions to a DAF, a charitable contribution deduction will only be allowed if the donor obtains a “contemporaneous written acknowledgment” from the sponsoring organization providing that the organization has exclusive legal control over the assets contributed.

Note that funds that benefit a single charity or governmental entity, or that provide grants to individuals for scholarships, travel or study are excluded from the definition if the donor provides advice on distributions only as a member of a decision-making committee and does not control or direct the distribution of funds.

Prohibited Transactions

The new law also enacts a range of prohibited activities, such as making loans to the donor or reimbursing the donor for expenses. It provides that DAFs cannot make grants to individuals or private non-operating foundations, or for non-

charitable purposes. Donors and their advisers are now disqualified persons for purposes of payouts or benefits from DAFs.

These disqualified person rules are similar to the private foundation rules. Any grants, loans, compensation or similar payments from a DAF to a donor, adviser or other related party will automatically be considered an “excess benefit transaction.”

Therefore, even though a family member of a donor may provide personal services to a DAF which are reasonable and necessary to carry out its exempt purposes, the compensation paid for such services will be considered an excess benefit transaction, subjecting the family member and the manager of the sponsoring organization to excise taxes.

Further, the DAF excess benefit rule will require the donor and family members to cover expenses for travel to board meetings and any expenses related to their personal efforts with respect to the charitable transfers.

Consequently, it will no longer be possible for family members to receive substantial salaries for services rendered to a DAF and trips, at the DAF’s expense, for the purpose of a family review of DAF grants will not be possible.

More Work to be Done

The PPA mandates a study of contributions to and distributions from DAFs to provide a full picture of the use of these funds in the philanthropic sector.

The study shall specifically consider:

• Whether the deductions allowed for income, gift or estate taxes for charitable contributions to sponsoring organizations of DAFs are appropriate in consideration of the use of contributed assets;

• Whether DAFs should be subject to minimum payout requirements;

• Whether the retention by donors of rights or privileges, including advisory rights is consistent with the treatment of such transfers as completed gifts that qualify for

a deduction for income, gift, or estate taxes; and

• Whether any of the issues described above also are issues with respect to other forms of charities or charitable donations.

The study must be submitted to the Senate Finance Committee and the House Ways and Means Committee by Aug. 17, 2007.

So, while DAFs provide benefits, it’s clear practitioners must tread carefully given the increased scrutiny.

Philip R. Lieberman, CPA, is a director at Irvine-based Clearview Financial Services, which provides advisory services on wealth transition strategies and

business succession planning. You can reach him at plieberman@clearviewplanning.com.