In recent years, donor-advised funds have become one of the most popular charitable giving vehicles. This popularity is fueled largely by the growth of community foundations (who can offer these restricted accounts) and the marketing from commercial brokerage firms of similar proprietary products known as "gift funds." Specifically, donors are attracted to donor-advised funds because they offer donors a significant degree of flexibility and control over fund distributions, as well as an immediate tax deduction for contributions.
Donor-advised funds are restricted funds maintained by the donee charitable organization. The donor makes an irrevocable contribution to the fund. In turn, the donor receives an immediate tax deduction (subject to limitations) and still retains the power to make recommendations or provide advice on the fund's distribution. In order to meet the statutory definition of a donor-advised fund, the fund must meet three requirements [IRC Sec. 4966(d)(2)(A)]:
1. The donor-advised fund must be solely owned and controlled by the sponsoring organization;
2. The donor-advised fund must be sequestered and separated from the sponsor’s general fund and specifically identified by reference to a specific donor (or group of donors) in that all contributions must be attributable to the named donor (or group).
3. The donor-advised fund must offer the donor advisory privileges with respect to distributions from the fund.
Click here for limitations on the charitable income tax deduction.
Deduction amounts are limited in the following ways:
Only donation amounts that surpass 0.5% of a donor's adjusted gross income qualify for a charitable deduction.
Donors in the 37% tax bracket have the tax benefit of their deduction limited to 35%.
Although the donor may provide advice, he or she may not place any material restrictions on the fund's distribution. A donor who places a material restriction on a donation has not made a complete gift. (Review the federal gift tax section on the requirements for a charitable gift.) Consequently, the donor will be ineligible to claim a charitable deduction for the donation.
What constitutes a material restriction is a question of fact that must be determined by looking at all of the facts and the circumstances. However, the following questions should be considered in determining whether a donor has placed a material restriction or condition on a contribution [Reg. Sec.1.507-2(a)(8)(i)]:
Who owns the assets received from the donor?
Are the assets held and administered by the donee charitable organization for the purposes of furthering the charitable organization's exempt purposes?
Does the donee charitable organization's governing body have the ultimate control over the assets?
Is the donee charitable organization's governing body organized and operated independently from the donor?
Factors used to identify an independent governing body include: the selection of the governing body, the terms of service for governing board members, and terms of renewal of service time for governing board members.
The following table illustrates the factors generally considered in determining whether the donor has placed a material restriction on his or her donated assets.
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Acceptable Control Factors |
Material Restriction Factors |
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Donee charitable organization's solicitations specifically state (either in writing or orally) that it will not be bound by donor's advice.
Donee charitable organization has conducted an independent investigation determining whether the donor's recommendations mesh with the organization's needs.
Donee charitable organization distributes a greater amount of funds than the donor-established funds to organizations similar to those advised by the donor.
Donee charitable organization has created guidelines outlining the charitable needs of the organization, for which the donor's advice is consistent.
Donee charitable organization includes an educational program that publicizes the guidelines outlining the organization's needs required to fulfill its charitable purposes.
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Donee charitable organization only solicits the donor's advice on distributions from the donor-established fund, without any procedure for seeking others' advice.
Donor advice is restricted to distributions from donor-established fund, without an independent investigation conducted to determine if advice is consistent with the organization's needs.
Donee charitable organization's solicitations declare (or imply), either in writing or orally, that donor's advice will be followed.
The donee charitable organization substantially follows the advice of the donor regarding distributions from the donor-established fund for the current tax year and all prior taxable years.
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Some financial services companies, such as Fidelity Investments and Vanguard Group, offer charitable funds similar to donor-advised funds, referred to as "gift funds." Gift funds operate in the same fashion as donor-advised funds with regard to deductibility and limitation requirements.
Community foundations have traditionally been the main providers of donor-advised funds. Community foundations offer many services to donors, including grantmaking assistance, a familiarity with potential donee charitable organizations, and the community's charitable needs.
Donors should investigate the community foundation's policies on distributions prior to making a contribution. Some community foundations place geographic restrictions on distributions from the funds.
Click here for more information about community foundations.
A donor takes an immediate income tax deduction for an irrevocable gift to the fund, which is eligible for the more generous deductibility limits available for gifts to public charities. A donor may claim a deduction on the contribution of up to 60% of a donor's adjusted gross income (AGI) for cash donations, and 30% of AGI for gifts of long-term appreciated property. (This is in comparison to more restrictive deductibility limits imposed on gifts to private foundations, which limits a donor to 30% of AGI for cash gifts, and 20% of AGI for gifts of long-term appreciated property.)
Excise Taxes
Excise taxes are imposed on a distribution from a DAF to any person for a purpose not specified under IRC Sec. 170(c)(2)(B). The DAF sponsoring organization is taxed 20% on any improper distribution. An additional 5% tax (not to exceed $10,000 per distribution) can be imposed on any fund manager who knowingly permits an improper distribution.
More than an Incidental Benefit
If a donor, donor advisor or related party provides advice on distributions that result (directly or indirectly) in a more than incidental benefit to that person or party, a tax of 125% of the benefit inured is imposed both on the advisor and the recipient. Any fund manager that knowingly approves a distribution that creates the benefit can be taxed up to 10% (not to exceed $10,000 per distribution).
Excess Business Holdings
The excessive business holdings rules outlined under IRC Sec. 4943 apply to donor-advised funds. A DAF may not own more than 20% of equity ownership in a business entity as defined by its voting stock. If a DAF owns more than the threshold amount, the DAF risks a 5% tax on the excessive holdings.
Automatic Excess-Benefit Transactions
Any grants, loans, compensation, and similar payments from donor-advised funds to donors, advisors, and related parties is considered an excess benefit transaction subject to the penalty taxes under IRC Sec. 4958. 25% of the value of the benefit plus the benefit itself must be repaid to the sponsoring organization (though not for deposit in the donor advised fund). Note that if the excess-benefit tax applies, the more than an incidental benefit tax does not.
Donor-advised funds offer many benefits to the donor. Click on any of the bullet points below to bring up a brief explanation.
Upon making a donation to a donor-advised fund, the donor may claim an immediate tax deduction for the contribution (subject to limitations).
Flexibility in advising about beneficiaries
Although a gift to a donor-advised fund is irrevocable, the donor might still provide advice on the size and time of the distributions.
Relief from administrative burdens
By making an irrevocable gift, the donor is relieved of the administrative burdens associated with the donated assets, such as recordkeeping, tax returns, etc.
More generous income tax deductibility percentage limitations
Donors who contribute to donor-advised funds are eligible for more generous deductibility limitations than those that apply to contributions to private foundations.
Donors who contribute to donor-advised funds are eligible for more generous deductibility limitations than those that apply to contributions to private foundations.
Generally, three main criticisms have been leveled at donor-advised funds. Click on the bullet points below to bring up a brief explanation.
May require larger administrative and investment fees
Critics argue that donor-advised funds require larger administrative and investment fees than other arrangements which cut into the donor's deduction.
Acts much like a private foundation, without the government-imposed safeguards
In addition, critics contend that the donor holds too much control over the funds, much like a private foundation, without the government-imposed restrictions applicable to private foundations. Consequently, critics contend that donor-advised funds may not be used for the charitable purposes for which the donor received a charitable deduction.
Donor does not have control over how the contribution is ultimately distributed.
Although the donor may make recommendations on distributions, and such recommendations are often followed, the donor does not "call the shots." Final discretion rests with the organization that controls the fund. This may be unappealing to some donors.
Click here to see a graphic of how donor-advised funds work.
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