In proposed regulations (REG-142338-07, released On November 13, 2023) under IRC Section 4966, the Treasury Department and IRS provide guidance for sponsoring organizations making taxable distributions from DAFs and DAF fund managers who knowingly agree to these taxable distributions. The guidance proposes (1) a definition of DAFs, (2) exceptions to the definition, and (3) criteria for when excise taxes will apply to DAFs or fund managers for making taxable distributions.

The regulations are only proposed; the final regulations will apply to tax years ending on or after the date they are published in the Federal Register; taxpayers can rely on the proposed regulations until that time.

Background

The proposed regulations interpret IRC Section 4966, which was enacted as part of the Pension Protection Act of 2006 to regulate DAFs.

DAFs allow individual donors to donate funds to a charitable organization, give nonbinding advice to the organization on how to distribute or invest the funds, and deduct the entire donation in the year it is given. DAFs have less stringent requirements than those that apply to private foundations.

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

IRC Section 4966(a)(1) imposes a 20% excise tax on each taxable distribution, payable by the DAF's sponsoring organization. A taxable distribution includes any distribution from a DAF to:

• Any natural person

or

• Any other person, if the distribution is for any purpose besides one specified in IRC Section 170(c)(2)(B) or the sponsoring organization does not exercise expenditure responsibility over the distribution in accordance with IRC Section 4945(h)

IRC Section 4966(a)(2) imposes a 5% excise tax on fund managers that agree to a taxable distribution knowing that it is a taxable distribution, payable jointly and severally by any fund manager that agreed to make the distribution.

IRC Section 4967 imposes an excise tax when any person described in IRC Section 4967(d) advises a sponsoring organization to make a distribution from a DAF that results in that person (or any other person described in IRC Section 4967(d)) receiving, directly or indirectly, a more than incidental benefit. Persons described in IRC Section 4967(d) generally include donors, donor advisors, family members of a donor or donor advisor and 35%-controlled entities of those persons. However, the proposed regulations do not interpret or apply to IRC Section 4967, which Treasury and the IRS will address in a separate guidance project.

The proposed regulations follow and expand on a series of IRS notices that provided preliminary guidance on DAFs in 2006, 2007 and 2017. In the most recent notice issued by the IRS in December 2017 (Notice 2017-73), the IRS described approaches being considered to address certain issues around DAFs and requested comments on those approaches (see Tax Alert 2017-2182). In response to these notices, the IRS and Treasury received 74 comments on DAFs and taxable distributions, which they took into account in preparing the proposed regulations.

Proposed regulations

Definitions

The proposed regulations would generally expand on the definitions of a DAF and a sponsoring organization in IRC Section 4966 and define other terms in IRC Section 4966 such as "donor" and "advisory privileges."

Separately identifiable

To qualify as a DAF, the fund or account must be separately identifiable by reference to contributions of a donor or donors. The proposed regulations specify that the sponsoring organization can show that the fund or account is separately identifiable if it maintains formal records tracking the contributions of the donor(s). If there is no formal record, whether the fund is separately identifiable would be based on all the facts and circumstances, including whether the fund or account balance reflects items such as contributions, dividends, interest, distributions, administrative expenses, and gains and losses (realized or unrealized) and whether the sponsoring organization generally solicits advice from the donor or donor-advisor before making distributions from the fund or account.

Donor

The proposed regulations explicitly exclude from the definition of donor (1) any public charity described in IRC Section 509(a)(1), (2), or (3) (other than a Type III non-functionally integrated supporting organization), and (2) any governmental unit described in IRC Section 170(c)(1).

Donor-advisor

The proposed regulations define donor-advisor as a person appointed or designated by a donor to have advisory privileges regarding the distribution or investment of assets held in a fund or account of a sponsoring organization. No particular form of appointment or designation of that donor-advisor would be necessary.

The proposed regulations identify three special rules with respect to donor-advisors:

1. A person who establishes a DAF and advises as to the distribution or investment of its assets in that DAF would be treated as a donor-advisor with respect to that DAF, regardless of whether that person contributed to the DAF
2. An investment advisor (other than an employee of the sponsoring organization) who manages the investment of, or provides investment advice concerning, both DAF assets and the personal assets of a donor to a DAF would be a considered a donor-advisor, unless the third special rule below applies
3. A personal investment advisor would not be considered a donor-advisor if the investment advisor provides services to the sponsoring organization as a whole

Advisory privileges

The proposed regulations clarify how to establish that a donor or donor-advisor has advisory privileges. The donor would be considered to have advisory privileges if any of the four conditions are present:

1. The sponsoring organization allows the donor or donor-advisor to provide non-binding recommendations
2. A written agreement states that a donor or donor-advisor has advisory privileges
3. Marketing materials indicate that a donor or donor-advisor may advise the sponsoring organization on distributing or investing the funds (for example, a pre-approved list of investment options or distributees that the sponsoring organization provides to a donor or donor-advisor)

or

4. The sponsoring organization generally solicits advice from a donor or donor-advisor regarding the distribution or investment of the fund or account

In the Preamble, the IRS and Treasury state that they generally regard service by a donor or donor-advisor on a committee of a sponsoring organization that advises on distributions from or investments of a fund's assets as a form of advisory privilege with respect to that fund, even if the sponsoring organization controls selection of committee members. The proposed regulations would permit a committee with one or more donors, donor-advisors or related persons to advise a fund or account without deeming those donors or donor-advisors to exercise advisory privileges over the fund under IRC Section 4966, if three conditions were met:

1. The sponsoring organization appoints the donor or donor-advisor based on objective criteria related to the appointee's expertise in the fund's purpose or particular field of interest
2. The committee consists of three or more individuals, not more than one-third of whom are related persons
3. The appointee is a not a significant contributor to the fund or account

Similarly, if a donor to an organization's fund recommends a person to serve on the fund's advisory committee, that person wouldn't be considered a donor-advisor vis a vis the fund if:

1. The sponsoring organization appoints the donor or donor-advisor based on objective criteria related to the appointee's expertise in the fund's purpose or particular field of interest
2. The committee consists of three or more individuals, and a majority of the committee is not recommended by the donor or donor-advisor
3. The recommended person is not related to the recommending donor or donor-advisor

Other exceptions

Under the proposed regulations, a DAF generally does not include any fund or account that makes (1) distributions only to a single identified organization, or (2) certain grants to individuals for travel, study or other similar purposes.

Distributions to a single identified organization

Under IRC Section 4966(d)(2)(B)(i), a fund or account is not a DAF if it is established to make distributions solely to a single identified organization or governmental entity. The proposed regulations define a "single identified organization" as an organization described in IRC Sections 170(c)(2) or 509(a)(1), (2), or (3) (other than a Type III non-functionally integrated supporting organization), and a "governmental entity" as an entity described in IRC Section 170(c)(1) (i.e., a state, a possession of the United States, or any political subdivision) if the distribution is made exclusively for public purposes. Accordingly, the proposed regulations clarify that a fund or account is a DAF -and does not qualify for the "single identified organization" exception - if it is established to make distributions solely to a single identified organization that is a (1) private foundation, (2) disqualified supporting organization, (3) foreign organization, or (4) non-charitable organization. The IRS is concerned that expanding this exception to these four types of organizations may allow circumvention of other tax provisions, including the private foundation rules and deduction rules for charitable contributions.

The proposed regulations would not treat a fund or account as making distributions only to a single identified organization if (1) a donor, donor-advisor, or related person reasonably expects to be able to advise on distributions from the single identified organization to other individuals or entities, or (2) a distribution from the fund or account will provide, directly or indirectly, a more than incidental benefit to a donor, donor-advisor, or related person with respect to the fund or account.

Grants to individuals for travel, study or other similar purposes

Under IRC Section 4966(d)(2)(B)(ii), DAFs do not include funds or accounts that exclusively make grants for travel, study or other similar purposes if those funds or accounts meet certain conditions. Under the proposed regulations, DAFs do not include funds or accounts with a selection committee that includes donors or donor-advisors and advises on which individuals receive grants for travel, study or other similar purposes, provided that:

1. Those donors and/or donor-advisors provide advice exclusively in their capacity as members of the selection committee
2. The selection committee members are appointed by the sponsoring organization
3. No combination of donors, donor-advisors or related persons control the committee, directly or indirectly
4. All grants are awarded on an objective and nondiscriminatory basis under a written procedure that is approved in advance by the board of directors of the sponsoring organization and designed to meet the requirements of IRC Section 4945(g)(1)-(3)

Whether the selection committee is controlled directly or indirectly by donors, donor-advisors or related persons would be based on facts and circumstances and determined by looking to the substance, rather than the form, of any arrangement.

Disaster relief fund

The proposed regulations except from the definition of a DAF a disaster relief fund that meets the requirements of IRC Section 139 (e.g., for a federally declared disaster). The proposed regulations do not extend this exception to emergency hardship funds, because the sponsoring organization or the fund's advisory committee — rather than the federal government — would determine what constitutes an emergency hardship, outside IRC Section 139 parameters.

Social welfare organizations

The proposed regulations also except from the definition of a DAF a fund or account established by a broad-based membership organization described in IRC Section 501(c)(4) if six conditions are met:

1. The fund's purpose must be to make grants to individuals for scholarships described in IRC Section 4945(g)(1)
2. The selection of scholarship recipients must be made by a selection committee whose members are approved by the sponsoring organization
3. The fund must serve a charitable class
4. Grant recipients must be selected on an objective and nondiscriminatory basis under a written procedure meeting the requirements of IRC Section 4945(g)(1)
5. No distribution may be made from the fund to (i) any officer, director, or trustee of the sponsoring organization, (ii) any member of the selection committee, (iii) any member or employee of the IRC Section 501(c)(4) organization, or (iv) any person related to anyone listed in (i), (ii) or (iii)
6. The fund must maintain adequate records to demonstrate that the recipients were selected on an objective and nondiscriminatory basis

Taxable distributions

The proposed regulations incorporate the statutory definition of taxable distribution under IRC Section 4966(c)(1). In addition, the proposed regulations include an anti-abuse rule that would treat a series of distributions through intermediary distributees as a single distribution under IRC Section 4966 if the distributions were undertaken to achieve a result that is inconsistent with IRC Section 4966. For example, if a donor advises on a distribution that the sponsoring organization makes from a DAF to a charity, and the donor arranges for that charity to use the distributed funds to make distributions to an individual recommended by the donor, then the distribution would be considered a taxable distribution from the sponsoring organization to the individual.

Excise taxes

The excise taxes outlined under the proposed regulations reflect those under IRC Section 4966(a)(1):

• 20% of the taxable distribution from a DAF, payable by the sponsoring organization
• 5% of the taxable distribution, payable by each fund manager that knowingly agrees to make the taxable distribution, up to a maximum of $10,000 for any one taxable distribution (all fund managers would be jointly and severally liable for the tax)

Under the proposed regulations, a fund manager's knowing agreement to make a taxable distribution would be evidenced by any manifestation of approval demonstrating the fund manager's authority to approve, or to exercise discretion in recommending approval of, the making of the distribution by the sponsoring organization, whether or not the fund manager is involved in the final approval.

Request for comments

Treasury and the IRS request additional comments on these proposed regulations by January 16, 2024. In addition to their general request for comments, Treasury and the IRS request comments throughout the Preamble to the regulations on the following:

• Any additional factors that would be relevant in determining whether a fund or account is separately identified by reference to contributions of a donor or donors
• The circumstances in which a gift agreement or advisory rights retained by a donor could create a DAF
• Circumstances that would indicate a personal investment advisor is providing services to the sponsoring organization as a whole, rather than just to the DAF, and additional circumstances in which a personal investment advisor should not be considered a donor-advisor
• Circumstances in which advisory privileges arising from advisory committees should not result in creation of a DAF
• What constitutes a "significant contributor" for purposes of the advisory committee exception to the definition of a donor or donor-advisor exercising advisory privileges over a fund
• Whether and in what circumstances exceptions are warranted to exclude multiple-donor funds from the definition of a DAF
• Whether additional guidance is needed to prevent avoidance of the employer-related scholarship rules or to address any potential private benefit arising from those programs
• How to identify a broad-based membership organization described in IRC Section 501(c)(4), and whether the 501(c)(4) DAF exception should also apply to other organizations, such as those described in IRC Section 501(c)(5) and/or 501(c)(6)
• How to distinguish DAF distributions that are subject to IRC Section 4966 taxable distribution restrictions from DAF investments that are not subject to such restrictions
• Whether any supporting organizations, other than Type III non-functionally integrated supporting organizations, should be considered "disqualified supporting organizations" that cannot receive distributions from a DAF under IRC Section 4966(c)(2)(A)

At a TEGE Exempt Organizations Council webinar on November 17, 2023, IRS Chief Counsel attorney Seth Groman reiterated the January 16, 2024 deadline for submitting comments, but said the IRS and Treasury will try to take into account any comments submitted after that date, if feasible.

Implications

These long-awaited regulations reflect and elaborate on the DAF rules in IRC Section 4966. They provide clarifications, examples and definitions of undefined terms in IRC Section 4966 that generally mirror definitions of those terms elsewhere in the Code. They hew closely to the text of IRC Section 4966 and do not stray beyond the statute to impose additional restrictions on DAFs that some critics have advocated, such as imposing annual minimum distribution requirements on DAFs.

The proposed regulations also highlight and fortify some traps for the unwary in IRC Section 4966. For example:

• Persons who collectively advise on investments in, or distributions from, a given fund, such as advisory committee members, could be considered donor-advisors vis-a-vis that fund, even if they did not donate to the fund, unless they meet a narrow advisory committee exception or another narrow exception.
• The proposed regulations would treat an investment advisor managing the investment of, or providing investment advice concerning, both DAF assets and the personal assets of a donor to that DAF as a donor-advisor, unless that investment advisor is an employee of the sponsoring organization or provides services to the sponsoring organization as a whole. Consequently, any payment by the sponsoring organization from the DAF to the a donor-advisor for investment advice would be a taxable distribution under IRC Section 4966, subjecting the organization to a 20% excise tax on the payment amount. Further, the investment advisor would be a disqualified person of the sponsoring organization under IRC Sections 4958(f)(7)-(8), and thus liable for an excess-benefit-transaction excise tax on the payment by the organization from the DAF under IRC Section 4958(c)(2), regardless of whether the payment is reasonable or excessive. But the IRS and Treasury have requested comments on circumstances in which a personal investment advisor should not be considered a donor-advisor for IRC Section 4966 purposes.

These proposed regulations are the first — but not the last — of DAF-related proposed regulations to be issued by the IRS and Treasury. Treasury's 2023-24 Priority Guidance Plan also includes guidance on (1) prohibited benefits to, and excise tax under IRC Section 4967 on, donors, donor-advisors, related persons, and fund managers for receiving a more than incidental benefit from a DAF; (2) excess benefit transactions involving DAFs under IRC Section 4958; and (3) the public support computation with respect to DAF distributions to public charities. The IRS and Treasury have not announced, and likely will not announce, when they will release such guidance.

In the meantime, sponsoring organizations, donors, donor-advisors, and related persons vis a vis DAFs may rely on the proposed regulations in interpreting and complying with IRC Section 4966, but are not required to do so; they may make other reasonable interpretations of IRC Section 4966 and take other reasonable positions until those proposed regulations are finalized.

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Published by NTD’s Tax Technical Knowledge Services group; Andrea Ben-Yosef, legal editor