Donor advised funds are an increasingly popular mechanism for individuals with charitable objectives who want to make a deductible charitable contribution in one year but make charitable distributions (grants) over a period of years. They are often recommended to such individuals as a preferable alternative to starting a private foundation. In general, a donor advised fund (“DAF”) is an account hosted by a sponsoring 501(c)(3) organization, usually a community foundation or a nonprofit affiliate of a financial services company, that is funded by a donor’s contributions in the form of cash, stock, or other assets. While the donor relinquishes legal control over the donation at the time it’s made, the donor retains advisory privileges as to the distribution of the funds and is generally able to benefit from a tax deduction on the contribution in the year in which it is made. In practical terms, the advice is generally followed by the sponsoring organization so long as grants to the identified grantees would not violate applicable laws or be outside of the sponsoring organization’s exempt purpose or mission.
Under the Pension Protection Act of 2006, a DAF is defined as 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
IRC Section 4966(d)(2)(A).
All three-parts of the above definition must be met in order for the fund or account to be characterized as a DAF. While the IRS has yet to provide regulations interpreting these requirements, the IRS released a Donor-Advised Funds Guide Sheet Explanation in 2008 that is instructive in a determination of whether a certain fund meets the test:
- Separately Identified Fund: In order to be a distinct fund or account for the purposes of prong one, the fund or account must refer to contributions of a specific donor or donors. The Guide Sheet provides that a distinct fund or account of a sponsoring organization does not meet this prong of the definition unless the fund or account refers to contributions of a donor or donors, such as (1) by naming the fund after a donor, or (2) by treating a fund on the books of the sponsoring organization as attributable to funds contributed by a specific donor or donors. While we have no authoritative guidance on what would constitute specific donors in this context, we agree with attorney Greg Colvin’s analysis* based on the legislative history that the term refers to related donors (including any member of the donor’s or donor advisor’s family or a 35% controlled entity of the donor or member of the donor’s or donor advisor’s family). Accordingly, if a sponsoring organization has established a restricted fund or account that is funded exclusively by contributions from a single donor or a group of related donors, regardless of the name of the fund, this requirement may be met. If the restricted fund or account is funded by contributions from a group of unrelated donors (which is often a characteristic of a giving circle), this requirement may not be met. Note, however, that that the number of unrelated donors and the relative contribution amounts of the different donors may impact this analysis.
- Owned and Controlled by a Sponsoring Organization: To meet the second requirement, the sponsoring organization, which must be a public charity, generally must have legal ownership and control over the assets following the contribution, and the fund or account must not be owned or controlled by the donor or other such person.
- Donor Has Advisory Privileges: Lastly, the donor or donor advisor must have, or reasonably expect to have, advisory privileges over the distribution, which may be evidenced in a written document or through the conduct of the donor, donor advisor, and sponsoring organization. Advisory privileges refers to the right of a donor or donor advisor to provide “noncompulsory recommendations, suggestions, or consultative advice” with respect to how the fund is granted out, but should be understood to be distinct from a donor’s legal right to control the donation.
DAFs are subject to several private foundation-like rules that sponsoring organizations may not ordinarily be subject to as public charities. These rules will be addressed in a follow-up post. Additionally, though long overdue, the IRS is expected to issue regulations on DAFs sometime in the near future. Potential areas of uncertainty that could be addressed include whether the IRS will impose a mandatory payout of funds being held in a DAF, similar to the 5% payout requirement applicable to private foundations, and other such private foundation rules that could reasonably capture DAFs.
IRS: Donor-Advised Funds
* Adler & Colvin: Is a Fiscal Sponsorship Maintained for a Project by a Public Charity also a “Donor Advised Fund?”