Recently, the Internal Revenue Service (“IRS”) and the U.S. Treasury Department (Treasury) released proposed regulations for donor advised funds (DAFs) under section 4966 (REG-142338-07) which includes updated proposed interpretive guidance surrounding excise tax on taxable distributions from a DAF.
The regulations propose changes to:
- The definition of a DAF
- The exceptions to the definition of a DAF
- The types of distributions that may be subject to excise taxes
What Is a DAF?
IRC Section 4966 defines a DAF as a fund or account which is:
- Separately identified by reference to contributions of a donor or donors.
- A fund or account is considered separately identified if the sponsoring organization maintains formal records relating to the contributions. For example, if a donor receives a fund statement from the fund, it would be considered separately identified funds.
- Owned and controlled by a sponsoring organization, and
- With respect to which a donor (or any person appointed or designated by such 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.
The proposed regulations note that the individual facts and circumstances would determine if advisory privileges existed based upon if the following are present:
- If the sponsoring organization allows the donor or donor-advisor to provide non-binding recommendations regarding the distribution of funds
- If there is a written agreement that states that a donor or donor-advisor has advisory privileges
- If a written document or marketing materials of the sponsoring organization indicates that a donor or donor-advisor may advise the sponsoring organization on distributing or investing the funds (for example, a pre-approved list of investment options or grantees)
- If the sponsoring organization generally solicits advice from a donor or donor-advisor regarding the distribution or investment of the funds
What Exceptions Exist?
The proposed regulations advise that a DAF does not include any of the following:
- A fund that makes distributions to a single identified Organization
- A fund that makes grants to individuals for travel, study or other similar purposes
In addition, the IRS’s definition of a DAF excludes the following:
- Disaster relief funds; Funds with a charitable purpose surrounding provider relief from one or more qualified disasters is excluded from the proposed regulations
- Certain scholarship funds whose committee is nominated by a 501(c)(4) membership organization such as a Rotary Club
Excise Tax Implications
The IRS defines a taxable distribution as a distribution from a DAF to any natural person or any other person unless the distribution is for a specified purpose and the sponsoring organization exercises expenditure responsibility.
Under IRC Section 4966, a 20% excise tax is imposed on a sponsoring organization for any taxable distribution from a DAF and a 5% excise tax on any fund manager that knowingly agrees to a taxable distribution (up to $10,000 per distribution).
The IRS notes that the fund manager would be considered to have agreed to the making of the distribution only if the manager:
- Is aware that it is a taxable distribution
- Has knowledge that the distribution would be a taxable distribution and negligently fails to make reasonable attempts to determine whether the distribution is taxable
The proposed regulations provide additional guidance surrounding when a donor or donor-advisor have the ability to advise on distributions from the recipient organization to further individuals or entities.
Noted within the preamble of the proposed regulations, “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.”
Based on this, if a donor or donor-advisor is a board member of a single organization and their DAF solely supports this organization, it appears that the donor has the ability to influence the use of the funds and thus could be considered a taxable distribution.
Analysis
The proposed regulations look to prevent abuse surrounding DAFs and are the first of multiple DAF-centric changes to be issued by the IRS and Treasury, which continues to be listed on their latest Priority Guidance Plan.
The IRS accepted comments on the proposed regulations through January 16, 2024. Upon the release of their final regulations, changes will be applicable to all tax years ending after the publication date. Proposed regulations may be relied upon until that time.
We recommend that all sponsoring organizations review the proposed regulations and evaluate their current DAF structures ahead of the finalization of these regulations.