In November of 2023, the Department of Treasury and the Internal Revenue Service published their first installment of proposed regulations providing guidance on operating and interpreting the tax provisions governing donor-advised funds (“DAF”). Before these proposed regulations, sponsoring organizations that manage DAFs had limited guidance to operate their DAF programs.
The new proposed regulations clarify and broaden the definition of accounts treated as DAFs and the distributions constituting taxable distributions, as well as other regulations for DAFs. In addition, future guidance for DAFs is also expected in the following areas:
- What constitutes a prohibited benefit under Section 4967? – a prohibited benefit that is more than incidental benefit to the donor; donor-advisors, related persons, and fund managers from the DAF.
- Excess benefit transaction under Internal Revenue Code (IRC) Section 4958.
- Tax treatment of DAF distributions to public charities for purposes of the public support computations under Section 509(a).
The proposed regulations will become effective for taxable years ending after the date when they are published as final regulations. Comments are requested on the proposed regulations by January 16, 2024.
This article will explain (1) the basic terms that are part of the definition of a DAF (2) the exceptions to a DAF and (3) the definition of a taxable distribution under IRC Section 4966. Although many questions are unanswered, the proposed regulations provide guidance that will affect the operations of a sponsoring organization with DAFs.
Definition of a DAF
Background – With certain exceptions, Section 4966 defines DAFs as a fund or account:
- that is separately identified by reference to contributions of a donor or donors;
- that is owned and controlled by a sponsoring organization (a public charity); AND
- with respect to which at least one donor or donor-advisor 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.
The proposed regulations provide clearer guidance to determine whether a DAF exists and broaden the definition of a DAF, by defining the “Bolded Words” above, which are explained further below.
| Key Words | Definition |
|---|---|
| Separately Identified | Before the proposed regulations, generally, if the fund did not reference the names of donor(s), the fund or account would not qualify as a DAF.
The proposed regulations provide that a fund or account is separately identified by reference to contributions if the sponsoring organization maintains a formal record of contributions to the fund of the donor(s). If there is no formal record, whether the fund is separately identifiable would be based on all the facts and circumstances. The following factors tend to show the fund is separately identified:
Exception – A fund or account solely funded by contributions from public charities (other than non-functionally integrated supported organizations) and governmental units described in Section 170(c)(2) are not treated as separately identified, and thus would not be considered a DAF. |
| Donor or Donor-Advisor | The proposed regulations define a donor, generally, as any person or entity, but specifically excludes public charities, other non-integrated supporting organizations, and governmental units under Section 170(c)(2). The definitions of donor and donor advisor are both extremely important in determining whether an arrangement is a DAF, but also in determining who may be subject to the excise taxes on taxable distributions.
The proposed regulations define a donor-advisor as a person appointed or designated by the donor to have advisory privileges regarding the distribution or investment of assets held in a DAF or a person to whom a donor-advisor delegates advisory privileges. There is no specific appointment form or designation that is necessary under the proposed regulations. A donor-advisor includes the following:
|
| Advisory Privileges | The proposed regulations expand when a donor or donor-advisor has advisory privileges that would result in DAF treatment. A facts and circumstances test is provided as to whether a donor has advisory privileges, regardless of whether the privileges are exercised.
A donor or donor advisor would have advisory privileges if any of the four factors exist:
In addition, the proposed regulations go on to provide additional special rules relating to advisory privileges. |
| Distribution | The proposed regulations provide that the term “distribution” generally means any grant, payment, disbursement, or transfer, whether in cash or in-kind, from a DAF. In addition, the proposed regulations expand the definition of distribution by defining “a deemed distribution.” Any use of DAF assets that results in a more than incidental benefit to a donor, donor-advisor, or related person is a deemed distribution that would generally be a taxable distribution.
The last section of this article will explain what constitutes a taxable distribution. The proposed regulations note distributions resulting in more than an incidental benefit to a donor, donor-advisor, or related party may also result in a prohibited transaction subject to the excise tax under Section 4967. |
Exceptions to the Definition of a DAF
The proposed regulations also expand and clarify the exceptions when certain funds or accounts are included in the statutory exceptions from the definition of a DAF.
- Funds that make grants to a single identified organization
A fund or account is not a DAF if it is established to make distributions solely to a single identified public charity or governmental entity. The proposed regulations define a “single identified organization” as an organization described in IRC Sections 170(c)(2) or 509(a)(1), (2), or (3) (other than a Type III non-functionally integrated supporting organization), and a governmental entity.
This exception does not apply if the donor, donor-advisor, or related party has or reasonably expects to have the ability to advise regarding distributions from the single identified organization or if a distribution from the fund or account will have a more than incidental benefit to a donor, donor-advisor or related party.
- Grants to individuals for travel, study, or other similar purposes
A fund or account that only provides scholarships, fellowships, or other grants is not a DAF if certain requirements are met. The proposed regulations also provide a facts and circumstances analysis to make sure the donor or donor-advisor is not directly or indirectly in control of the selection committee. Section 501(c)(4) organizations that are broad-based also meet this exception if certain conditions are met. In addition, the selection committee may be controlled by a Section 501(c)(4) organization.
- Disaster relief funds
Consistent with Notice 2006-109, the proposed regulations establish disaster relief funds or accounts that meet the requirements of IRC Section 139 (e.g., for a federally declared disaster) is not a DAF. The proposed regulations do not extend this exception to emergency hardship funds.
Definition of a Taxable Distribution
Background – Under Section 4966 a 20% excise tax is imposed on a sponsoring organization with respect to any taxable distribution from a DAF and a 5% excise tax on any fund manager that knowingly agrees to a taxable distribution.
The definition of “knowingly agrees to a taxable distribution” is interpreted broadly. A fund manager will be considered to know that a distribution is taxable if they know the distribution is taxable or if they have knowledge of facts sufficient to determine the distribution is taxable and fails to make reasonable attempts to determine whether the distribution is taxable.
The proposed regulation incorporates the definition of a taxable distribution found in IRC Section 4966(c)(1). A taxable distribution means any distribution from a DAF (1) to a natural person or (2) to any other person, if the distribution is for any purposes other than one specified in Section 170(c)(2)(B) or if the sponsoring organization does not exercise expenditure responsibility in accordance with Section 4945(h).
The proposed regulations include an anti-abuse rule providing that, if a series of distributions through intermediary distributees undertaken pursuant to a plan achieves a result that is inconsistent with the purposes of section 4966, these distributions are treated as a single distribution for purposes of section 4966.
For example, if a donor advises on a distribution that the sponsoring organization makes from a DAF to a charity, and the donor arranges for that charity to use the distributed funds to make distributions to an individual recommended by the donor which is inconsistent with Section 4966, then the distribution would be considered a single distribution, and a taxable distribution from the sponsoring organization to the individual.
The proposed regulation also provides the following guidance regarding taxable distributions:
- Distributions to a foreign organization are not a taxable distribution if the sponsoring organization exercises expenditure responsibility or obtains an equivalency determination in accordance with Section 4945.
- Distributions to an organization that is not a charity described in Section 170(b)(1)(A) is not a taxable distribution as long expenditure responsibility is exercised.
- Incorporates the expenditure responsibility rules applicable to grants by private foundations with slight modifications.
- A taxable distribution is a distribution that is used for non-charitable activities including a distribution for lobbying, even though public charities are permitted to engage in a limited amount of lobbying.
Summary
Treasury and the IRS have requested comments on these proposed regulations by January 16, 2024. The application will likely affect numerous individuals and organizations. Sponsoring organizations should determine whether DAF certain funds or accounts are considered DAFs under the proposed regulations and whether their DAF structures comply with these proposed regulations.
If you have any questions regarding the proposed regulations, please contact your trusted Dean Dorton advisor.