Many families and individuals use donor-advised funds (DAFs) as an alternative to having their own private foundations — but a “side-car” DAF can also be used to complement a private foundation.
Stephanie Yan (GHJ Managing Director and Private Foundation Practice Leader) talks to Pegine Grayson (Senior Vice President/Client Advisor, Director of Philanthropic Services at Whittier Trust) about the use of DAFs in conjunction with private foundations.
Whittier Trust is the oldest and largest multi-family office headquartered in the west. With offices in Nevada, Washington and throughout California and high-net-worth clients in 38 states, Whittier Trust is dedicated to making a meaningful and lasting difference in all aspects of their clients’ wealth, family and legacy.
WHEN TO USE A DAF
Stephanie Yan: I have heard that many of your private foundation clients use a side-car DAF. Are those used in situations when their foundations otherwise cannot meet the minimum payout requirements?
Pegine Grayson: That could be one scenario. Our private foundation clients look to us to calculate the minimum payout requirement at the beginning of the year to plan out their giving for the year.
Foundations have one-year grace period to give out the undistributed income from the previous year in order to satisfy the minimum payout requirement. Some foundations may have the undistributed amount creep up over time. When that amount approaches the annual grants budget, it becomes dangerous.
If, for whatever reason, a grant falls through, the foundation may risk not meeting the minimum payout requirement for that year and be subject to a 30-percent excise tax. Side-car DAFs become very helpful in this case: A donation to a DAF — at least for now — counts toward the required payout, while the foundation avoids the scramble of making a hasty grant decision.
SY: Are there other reasons to use a side-car DAF?
PG: Yes, in fact, what I just described is not the main reason. I have seen many foundations use DAFs as what I call an “emotional pressure release valve.” In this world of political polarization, some family members have diametrically opposed values. They come together and try to carry out the mission of their family foundation, but they end up at each other’s throats over the directors’ discretionary grants. Others may be wary about associating the foundation or family name with certain causes. In these situations, we advise them to open up a side-car DAF with a name unassociated with the foundation or the family and move the discretionary grants to the DAF, which can then make the grants. Grants from the DAF can even be anonymous.
BENEFITS OF A DAF
SY: A DAF is not subject to excise tax like the private foundations, correct?
PG: Correct. One of my foundation clients is ideologically opposed to paying tax, even the 1.39-percent excise tax that the foundation is subject to. His foundation used to make grants to charities in the form of stock donations in order to avoid excise taxes on realized gains from liquidating the stocks. It was laborious and time consuming on the administrative side, not to mention that many small grantees do not even have brokerage accounts to accept those donations.
With our advice, they opened up a side-car DAF. Once a year, they move the entire grant’s budget in the form of stock transfers into the DAF, sell them inside the DAF tax-free and make grants out of the DAF by checks. This significantly reduced the administrative burden internally and got grants into grantees’ hands faster.
FUTURE CHANGES ON THE HORIZON
SY: Thank you for all the examples. A side-car DAF offers so much flexibility. It sounds like a great complement to any foundation. Is there a catch?
PG: The only caveat is that Congress has been fixated on changing some of the rules that apply to DAFs. The most recent bill, the ACE Act, would have made any contribution from a foundation to a DAF that is advised by a disqualified person not countable toward the foundation’s minimum distribution requirement. Another provision of that Act would have imposed an annual payout requirement on DAFs, similar to foundations. Yet another provision would eliminate the current ability of public charities to count donations from DAFs as “public support” for purposes of meeting their public support test. The bill did not pass, but I am sure we have not seen the last of these attempts at DAF regulation.
OTHER WAYS TO USE A DAF
SY: At the end of the life cycle of a private foundation, I have seen assets get divided and distributed into one or multiple DAFs. Have you worked with similar scenarios?
PG: Yes. DAFs can also be used as vehicles in the dissolution of a foundation. I have seen several foundations wind down and distribute the assets to DAFs that are controlled by the next generation.
One of my foundation clients has an elderly founder who is passionate about continuing the support of a program that he established at a specific nonprofit organization. We helped him establish a “designated fund” — a variation of a DAF — and moved some of the foundation’s assets into that fund, which will only make grants to support that designated program.
To learn more about DAFs and how they may benefit a private foundation, reach out to GHJ’s Private Foundations Team.