donor advised funds materials/ii-b.pdfdaf grants – public support test in past plrs, the service...

DONOR ADVISED FUNDS Heckerling Institute on Estate PlanningSession II-B - January 16, 2019

Christopher R. Hoyt Ruth MadrigalUniversity of Missouri (KC) Steptoe & Johnson

School of Law Washington, DCKansas City, Missouri

Goals for TodayWhat are Donor Advised Funds (DAFs)?What can DAFs do?

– Permissible grants– Impermissible investments, distributions, benefits

What’s new with DAFs? – Notice 2017-63– Controversy, policy considerations

How do DAFs compare to PFs?

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Donor Advised Funds a fund or account owned by a

sponsoring public charity where the donor (or a person appointed by the donor) can recommend grants and/or investments

Donor Advised Funds

lower administrative costs grants to any public charity able to take non-cash gifts grants to any public charity increased interest: the 2017 Tax Cut & Job Act

made it harder to itemize tax deductions; DAFs are perfect for strategy of “bunching gifts” into a single tax year so can itemize

Donor Advised Funds

2018 Donor-Advised Fund Report National Philanthropic Trust

$110 billion – assets held by DAFs$ 29 billion – contributions to DAFs$ 19 billion – grants paid by DAFs463,000 – Number of DAFs in 2017 2,400 – Organizations with DAFs

DONOR ADVISED FUNDS2018 Donor-Advised Fund Report National Philanthropic Trust

Donor Advised Fund Provisions Sec 4966 – Definitions, Distributions (20% penalty) Sec. 4943( e) – PF excess business holding laws apply Sec. 4958 – Entire loan or compensation to donor is

“excess benefit” Sec. 4967 – 125% penalty on donor for advising distribution

that provides donor “a more than incidental benefit” Sec. 170(f)(18) – no income tax deduction for gift to DAF

unless contemporaneous written acknowledgment (“CWA”) states “exclusive legal control”

Donor Advised Fund – DefinitionThe definition is important for: Charities with different types of funds under

“fund accounting”– which funds could have DAF penalties?– which funds must be reported on Form 990? Donors who could lose income tax deduction

– DAF’s CWA must mention “legal control”

Donor Advised Fund – Defined §4966(d)(2)

“The term ‘donor advised fund’ means a fund or account: i. separately identified by reference to contributions of a

donor or donors,ii. owned and controlled by a sponsoring organization,

and …iii. with respect to which a donor (or any person

appointed or designated by such donor) has, or reasonably expects to have, advisory privileges with respect to the distribution or investment of amounts held in such fund or account by reason of the donor's status as a donor.”

Donor Advised Fund – Defined §4966(d)(2)

CASE STUDY - Mrs. Smith intends to donate $5 million to the Metro Art Museum (a public charity) to establish the Smith Fund for Asian Art. The fund will acquire art from Asia. It is anticipated that some payments will be made from the fund to individuals (for example, to pay for travel to and from Asia).

There will be a committee of five people to oversee the fund at the museum:

PLAN A: Mrs. Smith will appoint all five members of the committee.

PLAN B: Mrs. Smith will appoint one person to the committee, and the museum will appoint the other four individuals, none of whom have any relation to Mrs. Smith.

Donor Advised Fund – Defined §4966(d)(2)

FUNDS THAT ARE NOT DAFsDistributes to only one identified

charity/government entityCASE STUDYFund A is established solely for the benefit of Public Charity B. Public Charity B requests that the sponsoring organization of Fund A make disbursements to other public charities that it works with in the same community. It also asks that Fund A make payments to individuals/ contractors that are working on one of its charitable programs.

Any issues?

Donor Advised Fund – Defined §4966(d)(2)

FUNDS THAT ARE NOT DAFsDesignated for a charityScholarship not controlled by donor

– ISSUE: Does a scholarship fund established at a community foundation by a Section 501(c)(4) organization (e.g., Rotary) qualify for the exemption from the definition of a DAF if all of the scholarship committee members are members of that organization?

Donor Advised Fund – Defined §4966(d)(2)

FUNDS THAT ARE NOT DAFsDesignated for a charityScholarship not controlled by donorRegulations might exempt when:

–Committee not controlled by donor“Control” – 509(a)(3) supporting org definition apply to DAFs?

–Restricted charitable purpose

Donor Advised Funds – Distributions

PERMISSABLE GRANTS:Any public charity or private operating

foundation, except a Type III NFI S.O. The sponsoring public charityAnother donor advised fundA foreign charity or civic organization, but only

if “expenditure responsibility” (like a private foundation) to assure charitable purpose.

Donor Advised Funds – Distributions

PROHIBITED GRANTS:A human being For a non-charitable purposeGrants to an organization other than a public

charity where the sponsoring charity failed to exercise “expenditure responsibility”

Donor Advised Funds – Distributions

PENALTIES IF PROHIBITED GRANTS

ON CHARITY: 20%

ON EMPLOYEE: 5% (max $10,000)

Donor Advised Funds – Distributions

PENALTIES IF PROHIBITED GRANTS

Example: A DAF pays a consultant $10,000 to fly to Asia to investigate possible art purchases for a museum. [A payment to an individual]

Penalty on charity: $2,000 (20%) Penalty on employee who knew: $500 (5%)

Donor Advised Fund Provisions Sec 4966 – Definitions, Distributions (20% penalty) Sec. 4943( e) – PF excess business holding laws apply Sec. 4958 – Entire loan or compensation to donor is

“excess benefit” Sec. 4967 – 125% penalty on donor for advising distribution

that provides donor “a more than incidental benefit” Sec. 170(f)(18) – no income tax deduction for gift to DAF

unless contemporaneous written acknowledgment (“CWA”) states “exclusive legal control”

Donor Advised Funds –Excess Business Holdings

The private foundation excess business holdings rules also apply to a fund that is a DAF. § 4943(e). In the case of a DAF, the persons who are

considered “disqualified persons” include: A.a donor (or advisor appointed by the donor),B.a member of such person’s family, andC.a +35% controlled business

Donor Advised Fund Provisions Sec 4966 – Definitions, Distributions (20% penalty) Sec. 4943( e) – PF excess business holding laws apply Sec. 4958 – Entire loan or compensation to donor is

“excess benefit” Sec. 4967 – 125% penalty on donor for advising distribution

that provides donor “a more than incidental benefit” Sec. 170(f)(18) – no income tax deduction for gift to DAF

unless contemporaneous written acknowledgment (“CWA”) states “exclusive legal control”

Donor Advised Funds –Excess Benefit Transactions

Different law than applies to other charitiesOther charities: penalty only on “excess

benefit” paid to disqualified person– 25% (later 200%) on DP; 10% on charity

managerDAFs: penalty on the entire amount of “any

grant, loan, compensation, or other similar payment from such fund” to a donor/advisor

Donor Advised Funds

CASE STUDY

A DAF reimburses the DAF’s donor [a “disqualified person”] $10,000 for her expenses to visit Asia for art purchases. Penalty on charity: $2,000 (20%)Penalty on employee who knew: $500 (5%)Penalty on DP: Initially $2,500 (25%) [EE 10%]Penalty on DP if not return $: $20,000 (200%)

–The $10,000 cannot be placed in any DAF

Donor Advised Funds

“EXCESS BENEFIT” TRANSACTION Different law than applies to other charitiesOther charities: penalty on “excess benefit” paid

to disqualified person-- Applies to either services or property sales

DAFs: penalty only “grant, loan, compensation, or other similar payment” to a donor/advisor–DAF excess benefit NOT apply to property sale

between DAF and donor/family member

Donor Advised Fund Provisions Sec 4966 – Definitions, Distributions (20% penalty) Sec. 4943( e) – PF excess business holding laws apply Sec. 4958 – Entire loan or compensation to donor is

“excess benefit” Sec. 4967 – 125% penalty on donor for advising

distribution that provides donor “a more than incidental benefit” Sec. 170(f)(18) – no income tax deduction for gift to DAF

unless contemporaneous written acknowledgment (“CWA”) states “exclusive legal control”

Donor Advised Funds –“more than an insubstantial benefit”

DEFINED: A donor/advisor recommends a distribution from a DAF and the donor/advisor (or a family member) “receives a more than incidental benefit” Section 4967EXAMPLE: DAF distribution for tuition payment

for own childPENATIES:

–125% tax on donor/advisor–10% tax on fund manager who knew of benefit

Donor Advised Funds –“more than an insubstantial benefit”

DEFINED: A donor/advisor recommends a distribution from a DAF and the donor/advisor (or a family member) “receives a more than incidental benefit” Section 4967

TAX POLICY & PERSPECTIVE–Charitable tax deduction under Section 170?–DAFs are mini private foundations?

Donor Advised Funds –“more than an insubstantial benefit”

DEFINED: A donor/advisor recommends a distribution from a DAF and the donor/advisor (or a family member) “receives a more than incidental benefit” Section 4967EASY: Donor cannot get charitable tax deductionUNCERTAINTY:

–DAF pays a pledge made by the donor/advisor–Donor attends fundraiser (“bifurcated grant”)

DAF Notice 2017-73 (December 4, 2017)

Distributions that may benefit a Donor

– Bifurcated payments

– Distributions satisfying a charitable pledge

Public support test for charities receiving distributions from DAFs/ sponsoring orgs

Requests comments on use of DAFs by PFs

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Notice 2017-73 - Concerns

More-than-incidental benefit to donor (§4767)– Pledges– Bifurcated Grants

“Contribution Laundering”– Using DAFs to turn donor’s support into public

support, a private foundation into a public charity

Avoidance of PF payout requirement

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Donor Pledges

Charity

Donor/Advisor

DAF

$100Pledge $100(no 170 deduction)

More than an “incidental benefit” to the Donor/Advisor?

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$100

Pledges Made by PF’s Donor vs DAF’s Donor

PRIVATE FOUNDATION– Cannot pay a pledge that is “legally binding”, but

can pay pledge that is not legally binding

DONOR ADVISED FUND – IRS Notice 2017-73– No 125% penalty if three conditions are met– It doesn’t matter whether pledge is legally binding

or not– More generous for DAFs than for PFs

Pledges Made by PF’s Donor vs DAF’s Donor

PRIVATE FOUNDATION– Cannot pay a pledge that is “legally binding”, but

can pay pledge that is not legally binding DONOR ADVISED FUND – IRS Notice 2017-73

– No 125% penalty if three conditions are met1. No reference to pledge when make distribution2. Donor not receive benefit (except incidental OK)3. Donor not attempt to claim charitable

– It doesn’t matter whether pledge is legally binding or not

– More generous for DAFs than for PFs

Bifurcated Grants

Charity

Donor/Advisor

DAF

$50 $450Ticketfull price = $500

FMV of food = $50

More than an “incidental benefit” to the Donor/Advisor?

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Donor Advised Funds – “bifurcated grants”

DEFINED: A donor/advisor recommends a distribution from a DAF for the charitable portion of a payment, and the donor/advisor personally pays non-deductible portion EXAMPLE: Attend a $100 charitable event where a

$20 meal is served; charitable deduction only $80 Notice 2017-73: This is a “more than insubstantial

benefit”– 125% tax on donor/advisor– 10% tax on fund manager who knew of benefit

THIS IS A PROPOSAL – THIS IS NOT YET LAW

Contribution Laundering

501(c)(3) = PF

Donor/Advisor

DAF

appreciatedreal estate

• Donor is a “substantial contributor,” and 501(c)(3) is PF with annual distribution requirement

• Donor deduction is basis, 20% of income limit

• 501(c)(3) is public charity because entire DAF contribution is public support – no annual distribution requirement

• Donor deduction is FMV, 30% of income limit

501(c)(3) = PC

Donor/Advisor

appreciatedreal estate

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DAF Grants – Public Support Test

In past PLRs, the Service concluded that a grant from a DAF to a charity was a grant from a publicly-supported charity. Logic: the sponsoring organization was a public charity.

Thus, in theory, a charity’s sole support might be grants from a single DAF and the charity would be able to avoid private foundation status because all of its support came from a public charity.

DAF Grants – Public Support Test

IRS Notice 2017-73: Proposed new rules1. a DAF grant will be treated as being received

from the donor who funded the DAF, 2. all anonymous contributions will be treated as

being made by one person, and3. distributions from a sponsoring organization will

be treated as 100% “public support” only if that charity states that the distribution was not from a DAF

What Is the Interaction of PFs with DAFs?

IRS Notice 2017-73: “The Treasury Department and the IRS request comments regarding the issues addressed in this notice and suggestions for future guidance with respect to DAFs. In addition, the Treasury Department and the IRS request comments with respect to the following:

“(1) How private foundations use DAFs in support of their purposes.

(2) Whether, consistent with § 4942 and its purposes, a transfer of funds by a private foundation to a DAF should be treated as a “qualifying distribution” only if the DAF sponsoring organization agrees to distribute the funds for § 170(c)(2)(B) purposes (or to transfer the funds to its general fund) within a certain timeframe.”

Policy, Controversy, and Predictions

Four Concerns Regarding DAFs

DAFs help donors get maximum tax advantages for their charitable contributions and don’t increase charitable giving

A “significant proportion” of DAF funds will stay in DAFs indefinitely and many DAF sponsors distribute little or nothing

DAF sponsors are not “real” charities – and DAF contributions divert funds that would otherwise have been contributed directly to “active nonprofits”

DAFs allow private foundations to avoid private foundation rules, including payout and transparency requirements

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DAF Donors get same tax benefits as others

But these are not “additional” tax benefits – they are the same benefits that wealthy donors to large, well-established charities get every day

DAFs help make these same tax benefits available to middle income donors – like small business owners who may dispose of their business once in a lifetime

Why are DAFs expected to show increased overall giving to justify tax benefits other donors receive?

How do DAFs help your organization engage donors and draw more resources to charitable activities in your community?

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What is coming and going in DAF accounts?

NPT survey shows average payout for DAF sponsors is about 20% – In the 2017 report, National Philanthropic Trust surveyed 979 DAF

sponsoring organizations, holding over $85 billion.(see https://www.nptrust.org/daf-report/recent-growth.html )

IRS reports median payout rate for DAF sponsors in 2012 of 10% percent – Statistics of Income, Nonprofit Charitable Organizations and Donor Advised

Funds, reports on data provided from Forms 990. In 2012, it reported on 2,121 sponsoring organizations, holding $52.9 billion. (see https://www.irs.gov/pub/irs-soi/soi-a-npco-id1603.pdf )

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DAF Sponsors aren’t “real” charities

“…at bottom, they function as middlemen, plain and simple. DAF accounts may be under the legal control of the DAF sponsor, but the whole point of the DAF is to cede effective control over the timing and substance of distributions to the donor or the donor’s designee. Legal niceties aside, when donated funds are in a DAF, they are not fully available to a charity to be used in pursuit of its charitable mission…”

“A payout rule is necessary because the public value of DAFs does not occur until such time as funds come out of the DAF and become fully available for use by a charitable organization.”

(Colinvaux and Madoff, 10/24/17)

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DAF Sponsors aren’t “real” charities

BUT there is value transferred as soon as the contribution enters “charitable solution”– It cannot go back to the donor or for any non-charitable

purpose– It can be saved or spent immediately for charitable purposes– Savings provides resources for the future and can be

leveraged– DAF assets may be more fully available to charity than gifts to

other charities– What is the difference between a PF and a DAF on this point?

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Recent DAF Policy Proposals

Prohibit private foundations from satisfying their payout obligations with contributions to DAFs.

Additional transparency

Charitable distributions from IRAs – extend to DAFs

Payouts for individual DAF accounts

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DAF Policy Proposals – Payout Requirement

Colinvaux and Madoff (2017 letters): All contributions, along with accumulated earnings, should be distributed within a specified period (e.g.,10 years)

“Camp Plan” (H.R.1, 2014): Effectively would require all contributions to a DAF to be distributed within 5 years by imposing an excise tax of 20% of any undistributed amount on the DAF sponsoring organization.

Similar “spend out” proposals, as well as annual payout requirements have been proposed for other charities with endowments

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Comparing DAFs to PFs and SOs

DAF vs PF vs SO

COST-BENEFIT CHOICES: Private Foundation Donor Advised Fund Supporting Organization

When would an advisor recommend one over another?

ANSWER: When There Is a Legal Difference that Matters to the Client Administrative costs Income tax deductionsOperational restrictions pose problems

Income Tax Factors

Gifts to a private non-operating foundation of appreciated property: can only deduct cost basis for gifts of real estate or closely-held stock– Better to give these assets to public charity (DAF or

S.O.) so can deduct the higher market value

Public charity (incl. DAF and SO) has higher annual deduction limitation (60% AGI) than P.F. (30% AGI)

Legal Regulation & Taxes

SELF DEALING TAXES

PF SO DAFProhibit sale ? Yes No NoProhibit loan ? Yes Yes YesProhibit paying donor for services?

No Yes Yes

Legal Regulation & Taxes

PF SO DAFMinimum payout? Yes –

5%Yes –3.5% (NFI)

No

Excess Bus. Holdings? Yes Yes (NFI)

Yes

Jeopardy Investments? Yes No NoTaxable expenditures? Yes No No*

Private Foundation

POSITIVES – control! control! control!– governing body, operations/grants & investments– can compensate related persons

NEGATIVES– lower income tax deduction for non-cash gifts (real

estate/closely-held stock)– strict and harsh private foundation taxes– high administrative costs – tax return, etc.– no privacy about assets, grants, etc.

Donor Advised Fund

POSITIVES – low administrative costs (no tax return)– strict/harsh DAF excise taxes– public charity tax status for donations (no donor

payments)– access to staff of community foundation– anonymity possible for assets, grants, etc NEGATIVES

– loss of legal control over investments– cope with policies of administering charity – excise taxes on excess business holding, etc

Supporting Organization

NEGATIVES & POSITIVES SIMILAR TO DAF, BUT ALSO: greater sense of independence and identity to have a

separate corporation or trust compared to just an account can often avoid DAF sponsor’s policies that are an

issue (e.g., limit on future generation involvement with DAF) less freedom in grantmaking? (must support only

supported organizations named in organizing documents)