On November 13, 2023, the Internal Revenue Service and Treasury Department released proposed regulations on donor advised funds (DAFs). We’ve been waiting on DAF regulations for more than 15 years since enactment of the DAF laws in the Pension Protection Act of 2006. During this period, DAFs have become the fastest growing area in the charitable sector and the subject of much controversy, particularly regarding whether they increase charitable giving or serve to warehouse wealth and power.

Some observers were hoping for a minimum distribution requirement for DAFs, but it appears that Treasury believes such a law would require legislative action by Congress. Nevertheless, the proposed regulations appear to be the first round with more expected.

The proposed regulations focus primarily on definitions and on the excise tax that can be imposed on sponsoring organizations and fund managers for taxable distributions under Section 4966 of the Internal Revenue Code (IRC). It’s important to know that they are still proposed regulations and subject to public comment. Some of the provisions that may attract a substantial amount of comments follow:

• The broad definition of distributions could mean that DAF funds may no longer be spent by sponsoring organizations on certain services, including those that provide more than an incidental benefit to a donor, donor-advisor, or related person.
• DAFs may no longer be able to compensate the donor’s personal investment advisor for investment advisory/management services specifically directed to the DAF because they would be swept into the definition of a donor-advisor.
• More individuals would be considered donor-advisors by the broadened definition, including certain advisory committee members whose privileges arise from service on an advisory committee, even if selected by the sponsoring organization and not the donor or another donor-advisor.
• Some single identified organization funds (also known as single entity funds) that had been considered an exception to the definition of a DAF under IRC 4966 would be swept back into the definition of a DAF if the single entity/grantee uses the grant to engage in its own grantmaking.

The following provisions are edited excerpts from the proposed regulations. We encourage you to review the proposed regulations in full if you are either going to comply with the proposed regulations or submit comments by the deadline on February 15, 2024 (extended on 1/9/24). Note that the section references are to the Internal Revenue Code.

Statutory Definition

Section 4966(d)(2)(A) of the Internal Revenue Code defines a “DAF” generally 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.

Separately Identified

In general, the proposed regulations would provide that a fund or account is separately identified by reference to contributions of a donor or donors if the sponsoring organization maintains a formal record of contributions to the fund or account relating to a donor or donors. A formal record exists regardless of whether the sponsoring organization commingles the assets attributed to the fund or account with other assets of the sponsoring organization, as long as the sponsoring organization tracks contributions of a donor or donors to the fund or account. A contribution would be defined as any gift, bequest, or similar payment or transfer, whether in cash or in-kind, to or for the use of a sponsoring organization.

The proposed regulations would provide that facts and circumstances that are relevant in determining that a fund or account is separately identified by reference to contributions of a donor or donors include: (1) the fund or account balance reflects items such as contributions, dividends, interest, distributions, administrative expenses, and gains and losses (realized or unrealized); (2) the fund or account is named after one or more donors, donor-advisors, or related persons; (3) the sponsoring organization refers to the fund or account as a DAF; (4) the sponsoring organization has an agreement or understanding with one or more donors or donor-advisors that such fund or account is a DAF; (5) one or more donors or donor-advisors regularly receive a fund or account statement from the sponsoring organization; and (6) the sponsoring organization generally solicits advice from the donor(s) or donor-advisor(s) before making distributions from the fund or account. 

Donor

The proposed regulations would explicitly exclude from the definition of donor (1) any public charity described in section 509(a)(1), (2), or (3) (other than a disqualified supporting organization) and (2) any governmental unit described in section 170(c)(1).

Donor-Advisor

Consistent with section 4966(d)(2)(A)(iii), the proposed regulations would define donor-advisor as a person appointed or designated by a donor to have advisory privileges regarding the distribution or investment of assets held in a fund or account of a sponsoring organization. If a donor-advisor delegates any of the donor-advisor’s advisory privileges to another person, that person also would be a donor-advisor. 

A donor-advisor generally would include a person suggested or recommended by a donor to have advisory privileges if the sponsoring organization provides such privileges. However, this rule would not apply if (1) the donor recommends an investment advisor who is properly viewed as providing services to the sponsoring organization as a whole, rather than providing services to the DAF, or (2) the donor recommends a person to serve on a committee of the sponsoring organization that advises as to distributions or investments of amounts in a fund or account if the recommendation is based on objective criteria related to the expertise of the member in the particular field of interest or purpose of the fund or account, the committee consists of three or more individuals and a majority of the committee is not recommended by the donor or donor-advisor, and the recommended person is not a related person with respect to the recommending donor or donor-advisor.

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.

An investment advisor described that manages the investment of, or provides investment advice with respect to, both assets maintained in a DAF and the personal assets of a donor to that DAF (personal investment advisor) would be a donor-advisor with respect to the DAF while serving in that dual capacity, regardless of whether the donor appointed, designated, or recommended the personal investment advisor. However, a personal investment advisor will not be considered a donor-advisor if the personal investment advisor is properly viewed as providing services to the sponsoring organization as a whole, rather than providing services to the DAF.

Advisory committee members recommended by a donor and appointed by the sponsoring organization would be donor-advisors, except as discussed below.

Advisory Privileges

The proposed regulations generally would provide that the existence of such advisory privileges depends on the facts and circumstances, including the conduct (and any agreement or understanding) of both the donor(s) or donor-advisor(s) and the sponsoring organization. A donor (or donor-advisor) may have, or reasonably expect to have, advisory privileges even in the absence of the actual provision of advice. Advisory privileges would include those arising from service on an advisory committee. The proposed regulations also would presume that advisory privileges of a donor or donor-advisor arise by reason of the donor’s status as a donor, except where specifically provided otherwise.

The proposed regulations would provide that the presence of any of the following four facts is sufficient to establish that a donor or donor-advisor has advisory privileges by reason of the donor’s status as a donor, regardless of whether they are exercised: (1) the sponsoring organization allows a donor or donor-advisor to provide nonbinding recommendations regarding distributions from, or regarding the investment of assets held in, a fund or account; (2) a written agreement states that a donor or donor-advisor has advisory privileges; (3) a written document or any marketing material of the sponsoring organization made available to a donor or donor-advisor indicates that a donor or donor-advisor may provide advice to the sponsoring organization regarding the distribution or investment of amounts held by a sponsoring organization (for example, a pre-approved list of investment options or distributees that the sponsoring organization provides to a donor or donor-advisor); or (4) the sponsoring organization generally solicits advice from a donor or donor-advisor regarding the distribution or investment of amounts held in a fund or account.

The proposed regulations would also provide four special rules relating to advisory privileges. First, if at least one donor or donor-advisor has, or reasonably expects to have, advisory privileges with respect to a fund or account or any portion of a fund or account, then advisory privileges by reason of the donor’s status as a donor exist with respect to that fund or account even if there are multiple donors to the fund or account.

Second, there would be special rules for advisory privileges arising from service on an advisory committee. Service on a committee of a sponsoring organization that advises as to distributions from or investments of assets of a fund or account would generally be considered as a form of advisory privilege with respect to that fund or account in determining whether the fund is a DAF, even if the sponsoring organization controls the selection of committee members.

However, a sponsoring organization’s appointment of a donor, donor-advisor, or related person to be on a committee that advises as to distributions or investments of amounts in the fund or account will not be deemed to result in advisory privileges by reason of the donor’s status as a donor if (1) the appointment is based on objective criteria related to the expertise of the appointee in the particular field of interest or purpose of the fund or account; (2) the committee consists of three or more individuals, not more than one-third of whom are related persons with respect to any of the others; and (3) the appointee is not a significant contributor to the fund or account, taking into account contributions by related persons with respect to the appointee, at the time of appointment. If an appointee or related person is not a significant contributor to a fund or account at the time of appointment but becomes one shortly afterwards, the IRS may find that the person has advisory privileges based on the facts and circumstances. 

Also, if the sponsoring organization appoints a person at the recommendation of a donor (or donor-advisor) to serve on the advisory committee, such person will not be considered to be a donor-advisor if (1) the recommendation is based on objective criteria related to the expertise of the member in the particular field of interest or purpose of the fund or account; (2) the committee consists of three or more individuals, and a majority of the committee is not recommended by the donor or donor-advisor; and (3) the recommended person is not a related person with respect to the recommending donor or donor-advisor.

Third, advice provided solely in a person’s capacity as an officer, director, employee (or in a similar capacity) of a sponsoring organization would not by itself give rise to advisory privileges by reason of a donor’s status as a donor. However, if, by reason of the person’s contribution to a fund or account, an officer, director, or employee of the sponsoring organization is allowed to advise on how to distribute or invest amounts in the fund or account, the person would be considered to have advisory privileges by reason of the donor’s status as a donor with respect to that fund or account.

Lastly, unless the special rule for officers, directors, and employees of a sponsoring organization applies, if a donor to a fund or account is the sole person with advisory privileges with respect to a fund or account, the advisory privileges would be deemed to be by reason of the donor’s status as a donor. 

Exceptions

Section 4966(d)(2)(B)(i) states that a DAF does not include a fund or account that makes distributions only to a single identified organization or governmental entity. Section 4966(d)(2)(B)(ii) states that a DAF does not include a fund or account with respect to which a donor or a donor-advisor provides advice regarding grants to individuals for travel, study, or similar purposes if (1) the donor’s, or the donor-advisor’s, advisory privileges are exercised exclusively in the donor’s or donor-advisor’s capacity as a member of a committee all the members of which are appointed by the sponsoring organization, (2) no combination of donor(s), donor-advisor(s), or persons related to such persons directly or indirectly control the committee, and (3) all grants are awarded on an objective and nondiscriminatory basis pursuant to a procedure approved in advance by the sponsoring organization’s board of directors, and the procedure is designed to ensure that the grants meet the requirements of section 4945(g)(1), (2), or (3).

Consistent with section 4966(d)(2)(B), the proposed regulations generally would provide that a DAF does not include any fund or account that makes (1) distributions only to a single identified organization, or (2) certain grants to individuals for travel, study, or other similar purposes. 

In addition, under section 4966(d)(2)(C), the Secretary has discretionary authority to exempt a fund or account from the definition of DAF if the fund or account is advised by a committee not directly or indirectly controlled by the donor or donor-advisor (and any related parties ^[9] ) or if the fund or account benefits a single identified charitable purpose. The proposed regulations would provide two exceptions to the definition of DAF under this discretionary authority: (1) an exception for disaster relief funds consistent with the exception originally set forth in Notice 2006–109, with some modifications, and (2) an exception for certain scholarship funds whose committee is nominated by a section 501(c)(4) organization with a broad-based membership.

This post will review the proposed regulations pertaining only to the single identified organization exception.

Single Identified Organization Exception

Section 4966(d)(2)(B)(i) states that a fund or account that makes distributions only to a single identified organization or governmental entity is not a DAF. The proposed regulations would provide that a fund or account will not be considered a DAF if, along with meeting the other requirements discussed in this section 2.A, it is established to make (and actually does make) distributions solely to a single identified organization that is either: (1) an organization described in sections 170(c)(2) and 509(a)(1), (2), or (3) (other than a disqualified supporting organization), or (2) a governmental entity described in section 170(c)(1) if the distribution is made exclusively for public purposes.

If the single identified organization loses its exempt status or ceases operating, the proposed regulations would provide an allowance to keep the fund from becoming a DAF. The sponsoring organization would be permitted to substitute another single identified organization if the substitution is conditioned upon the occurrence of a loss of exemption, substantial failure or abandonment of operations, or a dissolution or reorganization that results in the named single identified organization ceasing to exist, and the event is beyond the direct or indirect control of donor(s), donor-advisor(s), or related persons.

Under the proposed regulations, the sponsoring organization would be permitted to make distributions to the single identified organization for the single identified organization’s activities (and only activities other than administering DAFs or grant-making) and, thus, to make distributions to fund a specific charitable project (other than administering DAFs or grant making) of the single identified organization. However, the sponsoring organization could not make distributions directly to third parties on behalf of the single identified organization, such as by making distributions to third parties for goods, services, or incidental grant-making for a particular project or program, because the statute requires that the fund or account make distributions only to the single identified organization. Further, the proposed regulations would provide that distributions to the single identified organization may not be used to administer DAFs or to make grants.

In addition, the proposed regulations would provide that a fund or account will not be treated as making distributions only to a single identified organization if (1) a donor, donor-advisor, or related person has or reasonably expects to have, the ability to advise regarding distributions from the single identified organization to other individuals or entities, or (2) a distribution from the fund or account will provide, directly or indirectly, a more than incidental benefit (within the meaning of section 4967) to a donor, donor-advisor, or related person with respect to the fund or account. Thus, for example, if a donor establishes a fund to make distributions only to a single public charity, and the donor is on the Board of the public charity, then the fund would not be able to meet this exception because the donor has the ability to advise some or all of the distributions from the public charity to other entities.

Recognizing that a sponsoring organization may lack direct knowledge regarding the activities of the donor, donor-advisor, or related person with regard to the single identified organization, however, the proposed regulations would allow a sponsoring organization to rely on a certification from the donor that (1) no donor, donor-advisor, or related person has or reasonably expects to have, the ability to advise regarding distributions from the single identified organization to other individuals or entities, and (2) no distribution from the fund or account will provide, directly or indirectly, a more than incidental benefit (within the meaning of section 4967) to a donor, donor-advisor, or related person with respect to the fund or account, as long as the sponsoring organization lacks knowledge to the contrary.