A donor advised fund (DAF) is a philanthropic vehicle that individuals, families and organizations use to manage and streamline charitable giving. The greatest benefit of a DAF is simplicity and flexibility — donors contribute to a DAF and receive an immediate tax deduction for the donation. The funds are then held in the DAF account under a sponsoring organization (such as a community foundation) where the donor has reasonable advisory privileges over future grants from the contributed funds and investments.

The Pension Protection Act of 2006 (PPA) introduced limitations and penalties associated with the misuse of DAF funds. On Nov. 14, 2023, the IRS issued proposed regulations under IRC Section 4966 to impose excise taxes on “taxable distributions” made by sponsoring organizations from a DAF. The broad proposed definition of a “donor advisor” would subject these individuals to IRC Section 4958 excise tax on an “excess benefit transaction.”

OVERVIEW OF THE NEW IRS PROPOSED REGULATIONS

The proposed regulations would impose a 20-percent excise tax on taxable distributions which would be paid by the DAF’s sponsoring organization.

There is an additional five-percent excise tax on the fund manager who agreed to the distribution knowing it is a taxable distribution. A taxable distribution includes payments to any natural person or a distribution to an organization that is not exempt under IRC Section 170(c)(2)(B), which are normally known as public charities.

The DAF is allowed to exercise expenditure responsibility on distributions made to non-qualified organizations, a process similar to how private foundations avoid paying an excise tax on a taxable distribution. Part of the expenditure responsibility process is to ensure that the funds are used for a charitable purpose.

An excess benefit transaction is subject to a 25-percent excise tax on the excess benefit amount. When the value of the economic benefit provided exceeds the value of the consideration received. This particular tax is imposed on the individual who received the benefit and, in this case, is considered a donor advisor of the DAF.

HOW THE PROPOSED REGULATIONS IMPACT ON DONORS AND ADVISORS

In light of potential excise taxes imposed on donors (and by extension, their advisors) who misuse their advisory privileges, it is important to understand who can be regarded as having these privileges. The proposed regulations would provide that the presence of any of the following facts is sufficient to establish that a donor or donor-advisor has advisory privileges, regardless of whether they are exercised:

1. A donor or donor-advisor provides nonbinding recommendations on distributions or investments.
2. The sponsoring organization generally solicits advice from a donor or donor-advisor regarding distributions or investments.
3. The existence of a written agreement explicitly stating advisory privileges.
4. Written materials, including marketing documents, indicate the donor or donor-advisor's potential role in advising on distributions or investments.

Moreover, advisory privileges would be deemed to be created where:

1. A donor or donor’s advisor reasonably expects to have advisory privileges even in the presence of multiple donors to the fund.
2. The donor or donor’s advisor serves on an advisory committee.
3. Where an officer, director or employee of the sponsoring organization advises on a fund in their capacity as a donor.
4. Where an officer, director or employee of the sponsoring organization is the sole person with advisory privileges.

The presence of the above circumstances or conditions could expose the donor or donor’s advisors personally to potential excise taxes and penalties if the DAF is deemed to have made excess benefit transactions or taxable distributions from DAFs. This expansion of these imposed taxes highlights the IRS’ view that DAFs are being misused and require stricter oversight.

It is important to note that the regulations are not final and may be subject to change based on public comments and further consideration. Taxpayers should await final regulations as official authority though they may rely on the proposed regulations on an interim basis.

To learn more about these proposed regulations and how they specifically affect DAFs, please contact GHJ’s Nonprofit Tax Practice. To learn more about how individual donors and advisors are affected, please contact GHJ’s High Net Worth Practice.