IRS takes first step in reforming donor-advised funds

Driving the debates are questions about whether the country’s ultrawealthy are abusing the immediate tax deductions they receive from tucking money into DAFs, where the dollars can sit indefinitely or, more often, until donors decide which nonprofits to support. Many in the nonprofit world have opposed that characterization, arguing the accounts allow for an easy, no-frills style of giving that appeals to both wealthy and average American donors.

This week, the Internal Revenue Service held a public hearing to discuss its plan to regulate DAFs. The proposals include: altering the definition of what constitutes a donor-advised fund so that it applies to a broader swath of accounts; expanding the definition of donor advisers to include personal investment advisers who help manage assets in DAFs; and imposing new penalties on those who abuse the funds. If approved, the IRS would impose a 20% excise tax on donations that provide significant benefit to the donor, among other changes.

In question is the IRS’s interpretation of a 2006 law signed by President George W. Bush, which laid out the first comprehensive set of policies for donor-advised funds.

The IRS seems to be concerned that “there are abuses out there and there’s money going places it probably shouldn’t,” said Lloyd Hitoshi Mayer, a law professor at the University of Notre Dame.

DAF supporters urged the IRS to revise its plan, with some arguing that the proposed restrictions would make donor-advised funds less attractive when charitable giving is already on the decline. The proposed regulations are just a start; they don’t really touch on the third-rail issue of whether to require payout to nonprofits on a timeline.

Money piles in

The IRS proposal comes amid mounting concerns about money piling up in DAFs, with some calling for tighter regulations. Nearly $230 billion has been stashed into DAFs, which have surpassed private foundations in popularity among a new generation of donors. There are now almost 2 million accounts, nearly double the number that existed in 2018, according to the National Philanthropic Trust, a leading sponsor of the funds, which also publishes an annual report on their growth. Donors can create accounts at any nonprofit “sponsoring organization,” including community foundations.

DAF enthusiasts include philanthropist MacKenzie Scott, who was previously married to Amazon founder Jeff Bezos and has a net worth of roughly $34 billion. In recent years, she has distributed billions of dollars to nonprofits through DAFs at Fidelity Charitable, the National Philanthropic Trust, and Chicago Community Trust, Puck reported. Fidelity Charitable, which was created by financial services firm Fidelity Investments, is the nation’s largest grant maker. It gave $11.8 billion to charity in 2023, with more than 322,000 donors making grants through its DAF arm.

In January, Netflix co-founder Reed Hastings donated $1.1 billion in company stock to the Silicon Valley Community Foundation, a favorite donor-advised fund sponsor within the tech sector. SVCF holds 1,060 donor-advised funds and roughly $10.1 billion in net assets.

The easy-to-open accounts are also gaining preference with the less wealthy. Nearly half of all DAFs held assets valued at less than $50,000.

More than 70 people lined up outside of the IRS’s Washington headquarters Monday morning as part of the federal agency’s public hearing on proposed DAF regulations. Thirty-four people representing community foundations, fundraisers, lawyer associations, and public accountants, among others, spoke about the potential impact of the proposed regulations on Monday. Nearly a dozen more spoke during the virtual session on Tuesday. Many expressed dissatisfaction with the IRS plan.

Applying new restrictions and “compliance burden” on donors and DAF-sponsoring organizations could cause a further decline in charitable giving, warned Lisa Chmiola, who spoke on behalf of the Association of Fundraising Professionals. Charitable giving dropped 3.4% in 2022 to $499.3 billion. But Fidelity Charitable’s DAF distributions went up more than 5% in 2023 to $11.8 billion.

“In our estimation, the proposed regulations, if implemented, would lead to fewer dollars swiftly reaching nonprofits we care about, and we respectfully ask the Department of Treasury to reconsider its approach,” added Andrea Sáenz, CEO of Chicago Community Trust, one of the nation’s largest community foundations. The IRS is part of the Treasury Department.

The push to include investment advisers within the definition of donor advisers subject to enforcement action related to DAFs also was raised several times. Unlike investment advisers, donor advisers are not allowed to benefit directly from the account transactions they oversee.

The language should be stricken from the proposal, said Kevin Carroll, deputy general counsel at the Securities Industry and Financial Markets Association, which represents investment banks and asset managers.

Will new rules chill charitable giving?

A recent public letter signed by a bipartisan group of 33 House tax committee members also called the IRS proposal “overly broad” and warned of the possible “chilling effect” that would take place if investment advisers also became donor advisers and if the definition of DAFs was broadened to include certain funds held by public charities, such as those that have advisory committees that include donors.

It’s a shift from 2021, when another group of House and Senate members introduced a bill, the Accelerating Charitable Efforts Act, which would have offered immediate tax breaks to those who disburse money quickly from their donor-advised funds. The proposal was supported by some big names, including billionaire philanthropist John Arnold, when it was unveiled in 2020.

To the dismay of DAF critics, the IRS proposal doesn’t touch on whether donors should be required to pay out of their funds within a certain time frame to receive immediate tax breaks.

“That is a really big issue, the warehousing of wealth that people have gotten deductions today for and actually aren’t helping people for who knows how long into the future,” Hitoshi Mayer said.

But that isn’t something that the IRS and the Treasury Department would be able to address without congressional intervention because payout requirements weren’t included in current law, he said.