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In Notice 2017-73 (the Notice), the IRS has described proposed regulations that it is developing to address certain issues involving donor advised funds (DAFs). Specifically, the proposed regulations described in the Notice would:

1. Treat certain distributions from a DAF that pay for tickets to charity-sponsored events as resulting in more than an incidental benefit under Section 4967

2. Set conditions under which certain distributions from a DAF that the distributee charity treats as fulfilling a pledge would not result in more than an incidental benefit under Section 4967

3. Change the public support computation for certain organizations to prevent the use of DAFs to circumvent excise tax rules applicable to private foundations

Background

With certain exceptions, Section 4966(d)(2) defines a DAF as a fund or account that is (1) separately identified by reference to contributions of a donor or donors; (2) owned and controlled by a sponsoring organization; and (3) with respect to which the donor (or any person appointed or designated by the donor) has, or reasonably expects to have, advisory privileges with respect to the distribution or investment of the funds.

Section 4967 imposes an excise tax when any person described in Section 4967(d) advises a sponsoring organization to make a distribution from a DAF that results in such person (or any other person described in Section 4967(d)) receiving, directly or indirectly, a more than incidental benefit. Persons described in Section 4967(d) generally include donors, donor advisors, family members of a donor or donor advisor, and 35%-controlled entities of such persons.

The IRS issued two notices in 2006 and 2007 (Notices 2006-109 and 2007-21) that requested comments on various issues relating to DAFs. The IRS received a number of comments on the notices, and is considering incorporating some of the suggestions into new proposed regulations on DAFs.

Proposed regulations

Notice 2017-73 states that the IRS is in the process of developing proposed regulations that would comprehensively address DAFs. However, the Notice is intended to address and provide interim guidance on certain specific issues — some of which were raised in comments received on the notices issued 2006 and 2007.

The Notice states that, until further guidance is issued, taxpayers may rely on the rules described in the Notice with respect to certain DAF distributions permitted without regard to a charitable pledge (discussed below).

Certain DAF distributions providing more than an incidental benefit

The IRS stated that it agrees with comments that it has received suggesting that a distribution from a DAF to a charity that enables a donor, donor advisor, or related person under Section 4958(f)(7) (collectively, a "Donor/Advisor") to attend or participate in an event results in the Donor/Advisor receiving a more than incidental benefit under Section 4967. Accordingly, the IRS stated that the planned proposed regulations would stipulate that a distribution from a DAF pursuant to the advice of a Donor/Advisor that subsidizes the Donor/Advisor's attendance or participation in a charity-sponsored event confers on the Donor/Advisor a more than incidental benefit under Section 4967.

Certain DAF distributions permitted without regard to a charitable pledge

The IRS noted that some comments that it has received expressed uncertainty about whether a Donor/Advisor may advise a distribution from a DAF to satisfy a Donor/Advisor's pledge to make a distribution to a charity. In this respect, the IRS stated that it agreed with some comments expressing concern that it may be difficult for sponsoring organizations to differentiate between a legally enforceable pledge by an individual to a third-party charity and a mere expression of charitable intent. With respect to DAFs, the IRS added that it believes that the determination of whether an individual's charitable pledge is legally binding is best left to the distributee charity, which has knowledge of the facts surrounding the pledge.

Accordingly, the planned proposed regulations would provide that distributions from a DAF to a charity will not be considered to result in a more than incidental benefit to a Donor/Advisor under Section 4967 merely because the Donor/Advisor has made a charitable pledge to the same charity — provided that the sponsoring organization makes no reference to the existence of any individual's pledge when making the DAF distribution. Specifically, a distribution from a DAF to a charity to which a Donor/Advisor has made a charitable pledge will not be considered to result in a more than incidental benefit to the Donor/Advisor if all of the following requirements are satisfied:

1. The sponsoring organization makes no reference to the existence of a charitable pledge when making the DAF distribution

2. No Donor/Advisor receives, directly or indirectly, any other benefit that is more than incidental on account of the DAF distribution

3. A Donor/Advisor does not attempt to claim a charitable contribution deduction under Section 170(a) with respect to the DAF distribution, even if the distributee charity erroneously sends the Donor/Advisor a written acknowledgment in accordance with Section 170(f)(8) with respect to the DAF distribution

The IRS noted that this special rule would apply for purposes of Section 4967 only, and it is not intended to alter tax treatment under any other Code section.

Preventing attempts to use a DAF to avoid 'public support' limitations

Publicly supported organizations generally receive a substantial part of their support from governmental entities and contributions from the public. In determining whether an organization qualifies as "publicly supported," the organization generally may treat contributions from a person as support from the general public (public support) only to the extent that such person's total contributions to the organization during the period do not exceed 2% of the organization's total support during the period (the 2% public support limitation).

The IRS stated that it is aware that some donors and charities seek to use DAF sponsoring organizations as intermediaries to circumvent the 2% public support limitation (i.e., by making contributions to DAFs maintained by sponsoring organizations and then advising the sponsoring organizations to make distributions from the DAFs to the charities).

The planned proposed regulations would prevent the use of DAFs to circumvent the private foundation rules and excise taxes. Specifically, the regulations would provide that a donee organization, for purposes of determining its amount of public support, must treat:

1. A sponsoring organization's distribution from a DAF as coming from the donor (or donors) that funded the DAF rather than from the sponsoring organization

2. All anonymous contributions received as being made by one person, and

3. Distributions from a sponsoring organization as public support without limitation only if the sponsoring organization specifies that the distribution is not from a DAF or states that no donor or donor advisor advised the distribution

Request for comments

The IRS requests further comments on the issues discussed in the Notice, and it also specifically requests comments on the following DAF issues:

1. How private foundations use DAFs in support of their purposes

2. Whether, consistent with Section 4942 and its purposes, a transfer of funds by a private foundation to a DAF should be treated as a "qualifying distribution" only if the DAF sponsoring organization agrees to distribute the funds for Section 170(c)(2)(B) purposes (or to transfer the funds to its general fund) within a certain timeframe

3. Any additional considerations relating to DAFs with multiple unrelated donors under the proposed changes described in the Notice with respect to preventing attempts to use a DAF to avoid public-support limitations

4. Methods to streamline any required recordkeeping under the proposed regulations described in the Notice with respect to preventing attempts to use a DAF to avoid public-support limitations

Implications

Sponsoring organizations of DAFs and publicly supported organizations should be advised that the IRS is considering issuing proposed regulations, and Notice 2017-73 outlines the changes being considered. One taxpayer-favorable outcome would generally allow a Donor/Advisor to advise a sponsoring organization to satisfy the Donor/Advisor's pledge to a charity, without incurring more than an incidental benefit. However, Donor/Advisors that receive admission to a charity-sponsored event, based on a distribution from their DAF-sponsoring organization, would incur more than an incidental benefit, and thus could be subject to excise tax under Section 4967.

Although the Notice is meant to solicit comments, the proposal regarding public support limitations for organizations described in Section 170(b)(1)(A)(vi) may be relied upon going forward. This could be a substantial change for some tax-exempt organizations. Generally, a Section 170(b)(1)(A)(vi) publicly supported organization must receive at least one third of its support from the government and/or public sources (i.e. not an individual source). Failure to meet this "public support test" could result in the organization being treated as a private foundation. Although contributions from "substantial contributors" exceeding the 2% limitation are not considered public support for amounts above the limitation, contributions from other publicly supported organizations do not have any limitation, and the entire contribution would generally be considered public support. If an organization applies the new rule, it would have to look through each publicly supported organization that is also a DAF-sponsoring organization, and apply the 2% limitation to each individual Donor/Advisor.

Organizations that receive significant donations from DAF-sponsoring organizations may want to internally calculate their public support based on these proposed rules to consider how this change may impact their public charity status. Guidance on DAF contributions for pledges may be relied on until regulations are issued by the IRS. However, organizations are advised to monitor and review further guidance as it becomes available.

Please contact your Ernst & Young LLP professional for further information.

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