Fiscal Sponsorship & Proposed DAF Regs?

A donor advised fund (“DAF”) is generally defined in Section 4966(d)(2)(A) of the Internal Revenue Code as a fund or account

  1. that is separately identified by reference to contributions of a donor or donors,
  2. that is owned and controlled by a sponsoring organization, and
  3. with respect to which a donor (or any person appointed or designated by the donor, namely, a donor-advisor) has, or reasonably expects to have, advisory privileges with respect to the distribution or investment of amounts held in the fund or account by reason of the donor’s status as a donor.

On November 13, 2023, the Internal Revenue Service and Treasury Department released proposed regulations on DAFs (the “Proposed Regs”) which has attracted a number of comments and criticisms, including with respect to how broadly the regulators are defining a DAF, in some cases beyond what the legislative history appears to support and, according to many (including me), in some cases in a way that will harm charities and their beneficiaries. I believe it’s nobody’s intent to prevent some diversions of charitable funds at the cost of decreasing exponentially greater amounts of resources from being deployed for charitable purposes.

But what does this have to do with fiscal sponsorship?

Well-informed fiscal sponsors have recognized for many years that the restricted fund held for the purposes of a fiscally sponsored project (FSP) could in certain cases fall within the definition of a DAF. If there was one or several related donors who started and funded the FSP within a fiscal sponsor and had advisory privileges with respect to grants made by the FSP to other entities, the restricted fund associated with the FSP (or part of such fund) could constitute a DAF by meeting all three elements in the statutory definition. See, e.g., Two Vehicles, One Home: Fiscal Sponsorship and Donor Advised Funds.

But the Proposed Regs, if finalized and made into law, adopt a much broader definition of a DAF that could encompass a great many FSP restricted funds within the definition.

First Prong of the Definition – Separately Identified

Before the proposed regulations, most fiscal sponsors and their advisors believed that a restricted fund associated with an FSP (the “FSP Restricted Fund”) to which multiple, unrelated donors contributed would not be a DAF. In the post Two Vehicles, One Home: Fiscal Sponsorship and Donor Advised Funds, I referenced the following excerpt from the legislative history relating to the Pension Protection Act of 2006 and its definition of a DAF, available at (download):

The first prong of the DAF definition requires that a donor advised fund be separately identified by reference to contributions of a donor or donors. 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 by naming the fund after a donor, or by treating a fund on the books of the sponsoring organization as attributable to funds contributed by a specific donor or donors. Although a sponsoring organization’s general fund is a “fund or account,” such fund will not, as a general matter, be treated as a donor advised fund because the general funds of an organization typically are not separately identified by reference to contributions of a specific donor or donors; rather contributions are pooled anonymously within the general fund. Similarly, a fund or account of a sponsoring organization that is distinct from the organization’s general fund and that pools contributions of multiple donors generally will not meet the first prong of the definition unless the contributions of specific donors are in some manner tracked and accounted for within the fund. Accordingly, if a sponsoring organization establishes a fund dedicated to the relief of poverty within a specific community, or a scholarship fund, and the fund attracts contributions from several donors but does not separately identify or refer to contributions of a donor or donors, the fund is not a donor advised fund even if a donor has advisory privileges with respect to the fund.

In the past, reliance on the above guidance did not necessarily inform fiscal sponsors that a FSP Restricted Fund could not include one or more true DAFs within the FSP Restricted Fund . This may happen if the fiscal sponsor is tracking a part of the FSP Restricted Fund with respect to its specific donor or funder that has advisory privileges or reasonably expects to have advisory privileges regarding the investment or distribution of such part of the fund, which is not an uncommon scenario where the fiscal sponsor is acting as an intermediary that regrants funds to other parties.

However, under the Proposed Regs, an FSP Restricted Fund could meet the first prong of the DAF definition even if it consisted of contributions from multiple, unrelated donors. See the following examples in the Proposed Regs:

Example 8. Fifteen unrelated individuals establish Fund Q at sponsoring organization T. Each individual contributes to Fund Q, and these individuals constitute a committee appointed by T to advise on investments and distributions from Fund Q. T regularly issues a statement to one of the committee members (who shares the information with the others) showing the account balance and any transactions with Fund Q. Fund Q is a donor advised fund.

Example 9. Assume the same facts as in paragraph (e)(8) of this section ( Example 8), except that the advisory committee consists of three of the donors, rotated annually. Fund Q is a donor advised fund.

Second Prong of the Definition – Owned and Controlled

An FSP Restricted Fund is owned and controlled by a fiscal sponsor. There never was a question of whether this prong of the definition was met.

Third Prong of the Definition – Advisory Privileges by Reason of Donor’s Status as Donor

Under the Proposed Regs, an FSP Restricted Fund may meet both the first and second prongs of the DAF definition, but many fiscal sponsors believe that they can still keep the FSP Restricted Fund from becoming a DAF by not permitting a donor to have advisory privileges with respect to the distributions or investments or to appoint a donor-advisor with such privileges. But there’s a special rule that may still bring an FSP Restricted Fund within the definition of a DAF. See the following example in the Proposed Regs:

Example 10. N, an individual, establishes Fund O at W, a sponsoring organization. Fund O serves as a memorial to N’s daughter, and receives many contributions from unrelated individuals. N is the only person with advisory privileges and thus is a donor advisor. Fund O is a donor advised fund.

Then, note the language in the preamble to the Proposed Regs (emphasis added):

[A] person (other than a person or governmental unit excepted from status as a donor) who establishes a fund or account and advises as to the distribution or investment of amounts in that fund or account would be treated as a donor-advisor with respect to that fund or account, regardless of whether the person contributes to the fund or account. For example, if a person establishes a memorial or fundraising fund to which the person does not contribute, but does provide advice regarding distributions from the fund, the person would be considered a donor-advisor. The donors to the fund have implicitly designated the advisor to have advisory privileges.

In short, donors to an FSP Restricted Fund established by a natural person who is not a donor and who has no other relationship to any donor may have implicitly designated this person to have the requisite advisory privileges to turn the FSP Restricted Fund into a DAF. This may be true if such person actually has such advisory privileges, possibly because they are the FSP project director, as is commonly the case. Under the Proposed Regs, we know that advisory privileges over distributions includes advisory privileges over grants, payments, disbursements, or transfers, whether in cash or in kind. The only exceptions to this extraordinarily broad definition of distributions are: (1) investments, (2) reasonable investment fees, and (3) reasonable grant-related fees.

Ramblings that Need More Development

So, if a natural person establishes an FSP and then runs the FSP as a project director advising on payments to be made out of the FSP Restricted Fund (a typical project management function), the FSP Restricted Fund may need to be managed as a DAF and follow all of the DAF rules.

But wait … what if the same person was hired by the fiscal sponsor to be an employee of the fiscal sponsor? Under the Proposed Regs, “[a]dvice provided solely in a person’s capacity as an officer, director, employee (or in a similar capacity) of a sponsoring organization does not by itself give rise to advisory privileges by reason of a donor’s status as a donor.”

Is that the solution? Or is that another trap because if the person who establishes the FSP Restricted Fund is deemed to be donor-advisor, they cannot receive more than an incidental benefit from the FSP Restricted Fund?

What if that person is paid by the fiscal sponsor from other funds and not from the FSP Restricted Fund? Could the fiscal sponsor charge a higher “administrative fee” to the FSP Restricted Fund noting that the fiscal sponsor’s administrative costs, including paying a project director with general funds, would be substantially higher than if the FSP Restricted Funds could be used to pay the project director?

There’s so much more to consider with the Proposed Regs. Here’s hoping some of these issues get raised in the public hearing in May and resolved in a way that does not harm proper and beneficial fiscal sponsorship. More fiscal sponsors, funders, charity advocates, and state charity officials may need to raise their voices about the threat the Proposed Regs may have on fiscal sponsorship.