Hot Off the Presses: A First Take on the Proposed DAF Regulations
We now have DAF (proposed) regulations! If that seems like a strange thing for a human being to apply an exclamation point to (it is), consider that there are hundreds of billions of dollars in donor-advised funds (DAFs), with complex rules and prohibitions but barely any real guidance. The DAF rules were created by the Pension Protection Act on August 17, 2006. There are human beings driving cars and getting ready to vote in the next Presidential election who have never known a world without the DAF rules. And today marks the first proposed regulations.
And after today… well… we still have some questions. But it’s something!
Considering that these regulations have been nearly twenty years in the making, it would be prudent to do a slow and careful review of the regulations and advise on what they portend for the donor-advised fund (DAF) world and the nonprofit sector. But I find hasty overreactions more fun to write, so here are some key takeaways from these proposed regulations, released today.
What is NOT in There:
Let’s start by managing your expectations and telling you a few things you will NOT find in these regulations:
· Anything about a minimum distribution requirement or a required timeline to distribute. While there has been a lot of criticism and chatter about this in the context of the ACE Act and similar proposals, this is something Congress would need to act on for there to be a change. You may have heard that Congress is not exactly in the “passing laws” business right now, and they certainly are not in the “help out the IRS” business. At least for now, there’s no sign of the Treasury or IRS trying to step in to fill that void when it comes to whether there are too many charitable dollars sitting in DAFs.
· Anything about using DAFs to circumvent the public support test. We know that the IRS thinks there should be changes that prevent nonprofits that would normally be foundations from earning and maintaining public charity status by having their major donor make their gifts through a DAF. However, these regulations do not touch the rule that DAF support generally counts as support from a publicly supported organization (driving the public support test percentage way up as though they were supported by a broad swath of the public, even if the money is really all coming from one person). So, the public support laundromat remains open for at least a little while longer.
· Private foundations using DAFs to satisfy their minimum distribution requirement. We know that the IRS thinks that private foundations should not get to satisfy their 5% minimum distribution requirement by making a grant to a DAF and letting it sit there. But if the change is coming, it’s not in these regulations – so foundations can still stockpile away.
· A final answer on benefits received by donors on grants from their DAFs. We have some partial guidance around DAFs paying for tickets (bad) or DAFs satisfying personal pledge (OK -- at least temporarily under certain circumstances), but I was thinking the big DAF regulation release would include something incorporating Notice 2017-73 on those sorts of topics. But, nothing yet.
· Anything on Program-Related Investments. It would have been nice to see the IRS confirm that the concept of program-related investments (PRIs) from the foundation context can apply to DAFs. DAF sponsors are certainly out there offering that as an option but, because DAFs don’t have minimum distribution requirements, there is not a real consequence to calling something a PRI or not a PRI. Some information below touches on a similar concept (the zero-interest loan, which would be a kind of PRI) and helps confirm that charitable investment activity is OK, but it feels incomplete. Especially given what a prevalent and growing practice this is among major DAF sponsors.
At least some of those items may still be coming. Today’s proposed regulations only address IRC 4966, which only addresses the definitions of a DAF, a donor-advisor, and whether distributions to other organizations are taxable. One might assume that later regulations might come under IRC 170 or 509 (the impact of a DAF grant on a charity’s public support test), IRC 4958 (whether certain actions by a DAF constitute an excess benefit transaction), and IRC 4967 (taxes on DAF grants with a more than incidental benefit to a donor-advisor).
For now, we’ll just have to be satisfied with some exciting new definitions, exceptions, and multi-factor facts and circumstances tests.
What Is In There:
Defining a DAF. 99% of the time, we know whether something is a DAF or not. A philanthropist donates to a community foundation or commercial DAF sponsor associated with their investment banks, and they are told they can advise as many (or as few) grants as they want. The DAF sponsor says “Give to us, get your deduction now, and then you can ‘advise’ us where to send it. And it is ‘advice,’ but, you know… the kind of advice where we always listen as long as it’s legal. And where we don’t care about anyone else’s advice, including our own.” I think we all understand what this kind of DAF is and why it’s worthy of at least some regulation. Private foundations are highly regulated, and these DAFs operate a lot like mini-private-foundations. Those sorts of DAFs were not ambiguous.
But there are some hard cases out there. For example, when a bunch of private foundations get together and set up a joint fund for making grants to other entities, is that a DAF or not? If a community foundation establishes a fund with an advisory committee and a donor sits on that committee, is that a DAF or not? Is a fiscally sponsored project where the project manager is a donor a DAF?
The answer can make a big difference if the fund wants to make grants to individuals (DAFs cannot do that) or to a foreign entity (DAFs have extra limitations here). Depending on the situation, the answer was always some version of “maybe?” with some references to legislative history and trying to parse the statute.
Now that we have these proposed regulations, when a client asks me this question, I will finally have some stuff to point to (even if I still end up saying “maybe” or “it depends” – that is part of being a lawyer after all).
To oversimplify proposed Treas. Reg. 53.4966-3, the question turns on whether (a) the fund is “separately identified by reference to contributions of a donor or donors” (as defined) or (b) whether at least donor or donor-advisor has advisory privileges.
Some takeaways on those points:
· If there is a “formal record” of what portions of a fund are related to a particular donor or donors, it’s “separately identified”. And a formal record seems like just tracking who gave to the fund and how much. This seems like a very low bar to being separately identified by reference to a donor – every charity I know with a fundraising department tracks who gave to it and for what – how else are you going to go back for more money?
· If there is no “formal record”, well then it depends on “all the facts and circumstances.” Some of the facts and circumstances are a bit surprising to me, but I do think the takeaway is “if you have a fund that you try to hold out as something that a donor-advisor can track like ‘their’ account, then we’re generally calling it a DAF.” Between this test and the formal record definition reflected in the examples, it seems like a very large number of funds will pass at least this prong of being a DAF.
· The other component of being a DAF is having someone with advisory privileges. Whether there is someone with advisory privileges depends on…you guessed it… “all the facts and circumstances.” Serving on an advisory committee can be an advisory privilege, at least if it arises from the donor’s status as the donor. If someone is appointed to be an advisor by the DAF sponsor itself (and not by the donor), then that does not count as an advisory privilege, if the advisor is not a significant contributor, the committee is 2/3rd unrelated to the advisor, and the appointment is based on the advisor’s objective criteria.
· There is no “multiple donor” exception. It is possible for a DAF to have more than one donor under these proposed regulations. This is notable because the legislative history suggested that multiple donor funds were not DAFs. Looking at these Regulations though, some of the examples make quite clear that just pooling funds between donors is enough to make something a DAF, whether they advise the whole or just the part they contributed. I think this is going to disappoint some foundations that create multi-donor funds at public charities if this ends up being the final rule. I would expect some significant resources spent in the comment period to try to get an exception here so foundations can pool their money together.
· Being a director, officer, employee of a DAF sponsor does not make you a DAF advisor. Of course, if that individual is separately a donor-advisor to a DAF, then it still counts.
Exceptions for Single-Entity, Scholarship Funds. The DAF rules have always had an exception for a single-entity fund, which is a fund that makes distributions to a single identified organization. This has always been a bit of a strange one because we usually want to avoid ‘earmarking’ in the nonprofit world. But it’s been a common philanthropic practice for donors to establish a fund for X local charity at their local community foundation, and advise on the timing of distributions or the investments. Congress apparently decided since it’s all going to the same place, we don’t need to provide the same scrutiny to these types of funds as we do to DAFs that individuals treat like their ‘charitable checking account’.
Still, every exception you create leads to people trying to exploit it, so Treasury had some fairly common-sense rules for reining it in:
· The single organization needs to be a public charity or a government entity for charitable purposes. I always thought that was implied, but to avoid any doubt, Treasury is not on board with ‘single-entity’ funds that send money to a private foundation, foreign organization, a for-profit organization, a 501(c)(4) or anything else that is not a public charity.
· The distributions need to go directly to the single identified organizations. You can’t use a single-entity fund to make payments to third parties on behalf of the benefitted organization.
· The single-identified organization can’t just be another DAF or any other organization where the donor expects to have the ability to advise regarding some or all of the distributions. That means, at least according to an example from Treasury, that you cannot have a director of the identified organization be the advisor. I think that might catch some organizations by surprise here – I certainly would not have guessed that was off-limits, as community foundations generally want input from the charities for whom they maintain these funds.
· There is some codification of the “scholarship fund” and “disaster relief fund”, which have been around based on Treasury guidance, but now have a bit more detail in the Regulations. And an additional exception for scholarship funds created by member-based 501(c)(4)’s. Definitely worth a read if your organization maintains these sorts of funds, though nothing jumping out to me as groundbreaking.
Definition of a Distribution. One thing about being a tax lawyer is you eagerly await the definition of words that normal people would consider pretty obvious. Like “distribution.” I don’t think normal people have spent the last two decades asking what a distribution is. But the Proposed Regulations answering this question for DAFs is a big deal.
You see, DAFs cannot make ‘distributions’ to anything other than a public charity or private operating foundation, unless they exercise expenditure responsibility. Sounds simple enough – at least if you assumed distribution meant “grant.” But what if you assumed distribution meant any cash payment, including an investment or contract expenses? If it did, then you would have a rule that says a DAF can only invest in charities, which clearly doesn’t make sense. And what if a sponsor paid for some grant-advising services out of a DAF to support that DAF’s work? Did they make a taxable distribution to that service provider if the provider is not a charity?
Now we have answers, and I think they mostly make sense:
· In general, distribution refers to any payment of cash or any other transfer from a DAF…
· Except that “investments and reasonable investment or grant-related fees” are generally not considered distributions – so those investments can be made in or paid to anyone, just like charities…
· BUT if you break some of the other rules (make these investments or pay these fees in a manner that results in a more than incidental benefit to a donor or donor-advisor), then that IS a distribution, so that the appropriate penalties apply)
· The preamble of the regulations suggests that a zero-interest loan would NOT be an investment, so that could only be made to a charity or with “expenditure responsibility”). This is fine enough, though I would probably have drawn the line at “any PRI” requires ‘expenditure responsibility’ because I am not sure why a 0.1% interest loan should be treated any differently than a 0% interest loan – but you have to draw the line somewhere, I suppose.
· One notable takeaway: the only carved-out fees are for “grant-related” fees. That confirms something I have often told clients, but now have proof I was right: DAFs should not be used for direct charitable activity. DAFs are for making investments and for making grants to charities from the income for those investments. A DAF cannot “hire” someone or “sign a contract” with someone. The DAF sponsor may incur some expenses and can charge some fees against it, but I would probably advise against trying to “run a program” out of a DAF
DAFs Can’t Lobby?? This one caught me by surprise. It has always been true that DAFs cannot make grants for non-charitable purposes. But public charities can do some lobbying/influencing legislation — there are limits to the amount of lobbying, but I would not call them non-charitable expenses if they advance their mission. In other situations (like the private foundation rules), when Congress wanted to prohibit lobbying, it did so as a separate prohibition. But here, Treasury is saying “distribution used for political campaign intervention activity or for attempting to influence legislation is considered to be for a purpose not specified in section 170(c)(2)(B).”
Very curious what others have to say here, but I think this is wrong and an overreach by Treasury. Prohibiting political campaign intervention? Sure — 501c3’s can’t do that at all — that’s not new. But I think applying it to lobbying is a logical leap unsupported by statute. And even if we accept that rule, it would be nice to have the private foundation regulations regarding grants, which have detailed exceptions (e.g. the general support exception and the McIntosh rule) to know when something is and is not lobbying. At a minimum, there is more work to be done here, and I expect to see some pushback.
(UPDATE: Worth noting that this statement is likely of limited effect. DAF distributions to public charities are automatically not taxable distributions. So, the above lobbying prohibition does not apply to grants to public charities. And grants to anyone else were already prohibited because expenditure responsibility requires that prohibition. So what does the above statement by the IRS accomplish? I don’t know — but I still think it’s notable that it signals a hostility to donor-advised fund lobbying, which is odd considering that public charities can spend resources on lobbying within limits.)
Expenditure Responsibility Translation Provisions. These are pretty self-explanatory, and not a surprise. DAFs also need to follow expenditure responsibility (ER) for grants to private foundations or non-charities and we all more or less figured out how to translate the rules from one context to the other. But now we have some specific rules and modifications to follow. Once these rules are final, DAF sponsors should start updating their ER grant agreements to match the new language.
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None of this has taken effect yet, and the provisions may change before they are finalized. But this is hopefully a decent first step towards a DAF sector with some clearer answers. (And if you don’t like the answers, we are in the comment period – so please get writing your letters to Treasury.)
