November 21, 2023
IRS releases proposed regulations for donor-advised funds
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.
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:
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.
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."
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.
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).
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:
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:
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:
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:
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:
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:
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.
The excise taxes outlined under the proposed regulations reflect those under IRC Section 4966(a)(1):
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:
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.
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:
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.
Published by NTD’s Tax Technical Knowledge Services group; Andrea Ben-Yosef, legal editor