Donor-advised funds (“DAFs”) are one of the most popular philanthropic vehicles in the United States. Donors give through DAFs to make an impact domestically, and also to contribute billions of dollars toward international causes on an annual basis. But regulatory guidance for DAF giving has not kept up with its increased popularity – until now!
On November 13, 2023, the IRS released its first of a few anticipated proposed regulations offering much needed clarifications on DAFs. The following sections provide a basic explanation of DAFs and their benefits, key definitional clarifications, DAFs’ advantages within a foreign grantmaking context, and related legal compliance aspects.
DAF - A Useful Charitable Tool
A DAF is a special fundraising or giving tool that allows donors (including individuals, companies, or exempt organizations) to make charitable gifts to a sponsoring organization without designating the ultimate destination of their contribution at the time of the gift. The sponsoring organization retains full legal control and oversight over the gift; however, it separately identifies the gift by reference to the donor and grants the donor advisory privileges over how and when funds are distributed.
DAFs have become increasingly common for numerous reasons. At the most basic level, donors may contribute assets such as cash, stocks, or other appreciated securities to a DAF, take an immediate charitable deduction, and then take their time to strategically advise grants to charitable organizations over the coming years. This flexibility permits donors to plan and execute their giving in a manner that aligns with their philanthropic goals, allowing for thoughtful consideration of the impact they wish to make in specific areas of need.
The sponsoring organizations – which are public charities – allow donors to also advise on investing the funds held in the DAF to generate additional investment returns that ultimately increase the funds’ charitable impact. This long-term growth is a similar operational model to private nonoperating foundations. A DAF thus may provide an attractive alternative to private foundations, which can be costly to establish and maintain. Contributing to a DAF allows a donor to focus more on the impact of their contributions rather than the complexities of foundation management.
Beyond these traditional uses for DAFs, public charities have increasingly utilized DAFs as an effective vehicle for facilitating peer-to-peer fundraising, corporate matching and grant programs, and other creative giving models, often affiliated with online platforms. These transactional DAFs operate under the identical DAF structure but generally require the donor to advise on immediate grantee(s), as opposed to periodically contributing funds to a DAF for later grant recommendations.
These public charities also receive and contribute billions of dollars each year toward charitable causes. Indeed, in 2022 alone, DAFs’ total combined giving power exceeded 52 billion dollars.[1]
Proposed IRS Regulations
In 2006, Congress enacted Section 4966 of the Internal Revenue Code as part of the Pension Protection Act. Section 4966 provided the first statutory definition for a DAF and created an excise tax to prevent DAFs from engaging in certain types of distributions.[2] As the prevalence and use of DAFs has continued to boom over the last seventeen years, regulators have identified specific transactions, relationships, and other circumstances that warrant increased guidance and legal parameters.
The proposed regulations only interpret Section 4966, and they are merely the first of what are likely to be a few different forms of regulatory guidance addressing DAFs’ permitted uses and restrictions in the coming years. Notably, four of the IRS’s ten items on its Priority Guidance Plan for Exempt Organizations involve DAFs. The IRS has therefore signaled its high prioritization of DAFs, through the proposed regulations and otherwise.
While the proposed regulations are narrow in scope, they address important definitional questions to the 2006 statutory terms for DAFs, a “donor-advisor,” “advisory privileges,” and a “distribution.” They also provide helpful examples to clear up the breadth and limitations of what types of activities fall within and outside the heightened restrictions on DAFs.
For example, the proposed regulations exclude public charities from the definition of a donor, meaning that public charities cannot maintain their own DAF accounts. They explain that a DAF does not include an account established to make distributions solely to a single public charity or to a governmental entity for public purposes. Likewise, an account maintained by a public charity that receives funding from multiple donors and does not provide advisory privileges to donors is excluded from the definition of a DAF.
The regulations also shed light on the legal requirements for sponsoring organizations to use DAFs to make grants to foreign organizations, and this blog specifically addresses those guidelines.
Impact on International Grantmaking by DAFs
Public charities have wide legal latitude to grant funds to international organizations that are not recognized as Section 501(c)(3) organizations.[3] The grant-making charity must: grant funds for specific projects that further the public charity’s purposes under Section 501(c)(3); maintain sufficient control and discretion over grantee’s use of the funds; and require periodic accounting from grantees establishing that the funds were in fact utilized for Section 501(c)(3) tax-exempt purposes.
But public charities serving as sponsoring organizations for DAFs are required by Section 4966 of the Code to adhere to more stringent procedures when granting funds to international organizations, and a sponsoring organization is subject to excise taxes for failing to comply. These new DAF regulations mirror the expenditure responsibility and equivalency determination procedures imposed on private foundations when they make international grants.[4]
The proposed regulations clarify that under Section 4966 of the Code, a public charity may grant funds from a DAF to an organization (but not individuals) not recognized as exempt under 501(c)(3) if it adheres to the same “expenditure responsibly” requirements established under Section 4945(h) for private foundations. Thus, the sponsoring organization will need to develop a (1) a pre-grant inquiry; (2) a written grant agreement; (3) reports from the grantee; (4) reports to the IRS; and (5) action upon noncompliance by the grantee. Expenditure responsibility requires extensive documentation and diligence to ensure compliance with IRS regulations.
The proposed regulations further clarify that, alternatively, a sponsoring organization may rely on a written “equivalency determination” issued by a qualified tax practitioner to make grants to foreign organizations, provided the equivalency determination process adheres to the updated guidelines issued by the IRS in Rev Proc. 2017-53. More specifically, if a sponsoring organization relies on a good faith written determination that the foreign grantee is equivalent of a public charity under Section 501(c)(3) (except for certain disqualified supporting organizations), then the sponsoring organization may grant the funds without undertaking the expenditure responsibility process.
Finally, the proposed regulations add helpful clarifications concerning what procedures sponsoring organizations should follow when making DAF grants to a foreign government (or agency or instrumentality of a foreign government) and to “international organizations” as designated by presidential executive order. In the landscape of foreign philanthropy, agencies of foreign governments and international organizations play a significant role. More specifically Congress has empowered the President of the United States to designate specific organizations as entitled to certain privileges, exemptions, and immunities, including equivalency for the purpose of charitable activities (See 22 USC § 288). These equivalent organizations include the United Nations, the World Trade Organization, the International Committee of the Red Cross, and dozens of others.[5]
The proposed regulations make clear that sponsoring organizations granting funds to these organizations are not required to use expenditure responsibility or equivalency determinations. Rather, grants to these organizations can be made under a basic requirement that the grant “is made exclusively for charitable purposes” (including religious, charitable, educational, etc.) as described in Section 170(c)(2)(B) for tax-exempt compliance.
What’s Next?
While these regulations are only proposed, a specific provision establishes that taxpayers may rely on these proposed regulations until they are finalized. The public comment period on the proposed regulations is currently set to run through January 16, 2024. One might presume that the regulations will be finalized shortly thereafter. However, this is far from certain; the final regulations may be published in 2024 or long after. The IRS’s priorities for preparing and finalizing regulations change consistently, especially as Congress enacts additional tax legislation. Notably, it took seventeen years from Section’s 4966 enactment for the publishing of these proposed regulations. Additionally, the nonprofit religious community has been waiting for much-needed regulations governing church audit procedures (7611) to be finalized since 1998. These types of government delays are why the explicit IRS guidance that taxpayers may rely on the proposed regulations immediately is a welcome amelioration to the potentially protracted delay on the regulations’ finalization.
[1] See the National Philanthropic Trust’s 2023 DAF report here.
[2] Code section 4966 provides that the term “donor advised fund” means a fund or account: (i) which is separately identified by reference to contributions of a donor or donors, (ii) which is 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.
[3] See our law firm’s blog summarizing the basic legal requirements here.
[4] For an in depth summary of expenditure responsibility, click here, and for equivalency determinations, click here.
[5] For a complete list of designated organizations, click here.
