Taxable Distributions for Donor Advised Funds
Public charities that hold donor advised funds must comply with special rules regarding payments from such funds. Provisions under the Pension Protection Act of 2006 require certain payments from donor advised funds to be made using expenditure responsibility, while certain other payments are expressly prohibited. The PPA imposes penalties on the sponsoring charity holding the donor advised fund and fund managers of that charity if certain distributions are made out of the fund.
- What payments are prohibited?
- What payments require expenditure responsibility?
- What is a Donor Advised Fund?
- What is a sponsoring organization?
- Can a donor advised fund pay administrative fees to the sponsoring organization?
- Can a donor advised fund make a grant to a scholarship fund, a designated fund or any another fund at the sponsoring organization?
- Can a donor advised fund make a distribution to a donor advised fund maintained by another organization?
- Can a grant be made to an operating foundation from a donor advised fund?
- Can a donor advised fund make a distribution to a private non-operating foundation?
- Are grants to international organizations permitted?
- Can a donor be reimbursed for expenses incurred hosting a fundraising event?
- Can a donor advised fund pay expenses directly to the caterer for a fundraising event?
- Can a donor advised fund award a scholarship grant?
- Can a donor advised fund make a distribution to a supporting organization?
- What is a Supporting Organization?
- Determining Supporting Organization Status
- Donor Advised Fund Expenditure Responsibility Flowchart
- What if I can’t tell what type of supporting organization a grantee is?
- What are the penalties?
- Who are fund managers?
- What is “expenditure responsibility”?
- When did these rules take effect?
- Where can I find the rule?
What payments are prohibited?
Distributions from a donor advised fund to an individual are prohibited. So too are distributions to any organization if not for a charitable purpose.
- an organization that is not described in section 170(b)(1)(A) – notably non-charities and private non-operating foundations
- a type III supporting organization that is not “functionally integrated”
- a supporting organization(even a “functionally integrated” type III) if an organization that is being supported is controlled by either the donor, an advisor designated by the donor or a related party
What is a Donor Advised Fund?
Find out how donor advised fund is legally defined under the PPA. Use our Donor Advised Fund Flowchart to help you identify when funds are donor advised.
What is a sponsoring organization?
A sponsoring organization is a public charity, such as a community foundation, that holds donor advised funds.
Can a donor advised fund pay administrative fees to the sponsoring organization?
Yes, payments from a donor advised fund to the sponsoring organization are specifically permitted by the Act without limitation and without the need to exercise expenditure responsibility.
Can a donor advised fund make a grant to a scholarship fund, a designated fund or any another fund at the sponsoring organization?
Yes, all payments from a donor advised fund to the sponsoring charity are explicitly permitted without the need for expenditure responsibility. This includes payments to any other fund at the organization, including to other donor advised funds.
Can a donor advised fund make a distribution to a donor advised fund maintained by another organization? Yes. The Act specifically allows distributions from a donor advised fund to another donor advised fund without limitation and without the need to follow expenditure responsibility rules.
Can a grant be made to an operating foundation from a donor advised fund?
Yes, with the exception of certain supporting organizations, the Act specifically permits grants to all organizations described in section 170(b)(1)(A) of the Internal Revenue Code without the need to follow expenditure responsibility. Operating foundations are among the organizations listed in section 170(b)(1)(A).
Can a donor advised fund make a distribution to a private non-operating foundation?
We recommend against making grants to private non-operating foundations. While the PPA lets a donor advised fund make a distribution to any organization (including a private non-operating foundation) as long as it follows expenditure responsibility, the legislation does not address preexisting concerns that a grant from a donor advised fund to the donor’s private foundation is evidence of excessive donor control that could cause recharacterization of the advised fund as a private foundation. The legislation also does not address the problem that arises when donors attempt to use gifts to donor advised funds to circumvent the deduction limits that otherwise apply to gifts to private foundations, While there are situations where it may be appropriate to make a grant from a donor advised fund to a private non-operating foundation, you should only do so after consulting with your tax advisor to evaluate these risks.
Are grants to international organizations permitted?
Yes. The legislative history makes clear that you have two choices in making such distributions. You may either make a good faith determination that the organization is equivalent to a domestic charity (equivalency determination) or you must exercise expenditure responsibility.
Can a donor be reimbursed for expenses incurred hosting a fundraising event?
No, this section prohibits all distributions to individuals from advised funds, regardless of the purpose. Additionally, changes to the intermediate sanctions rules under the PPA prohibit expense reimbursement to donors, advisors and related parties from a donor advised fund. The charity may choose to reimburse the individual out of unrestricted funds, but any effort to circumvent the rule by making a distribution from the general funds of the charity followed by a distribution from the donor advised fund back to the charity will likely trigger penalties.
Can a donor advised fund pay expenses directly to the caterer for a fundraising event?
We have sought guidance from the U.S. Department of Treasury on whether the prohibition on distributions to individuals includes payments to vendors, who are individuals, for goods and services and whether expenditure responsibility is required for payments to corporate vendors, and, if so, what form expenditure responsibility should take. Currently, no additional guidance has been issued.
Can a donor advised fund award a scholarship grant?
No. Grants to individuals are prohibited from donor advised funds. This includes checks written directly to an individual and checks written to an entity, such as a university, for the benefit of a specified individual.
However, grants to individuals out of funds other than donor advised funds are permissible. Also permissible are grants from donor advised funds to an entity (e.g. a university) that will make the selection of individuals without any involvement from the donor. Such grants are treated as a grant to the entity.
Can a donor advised fund make a distribution to a supporting organization?
Yes, however you must exercise expenditure responsibility for grants from a donor advised fund to Type III supporting organizations that are not “functionally integrated” and to any supporting organization (Type I, II or functionally integrated Type III’s) where a donor, advisor designated by the donor, or a related party, controls an organization that the supported organization supports.
What if I can’t tell what type of supporting organization a grantee is?
If in doubt, follow the expenditure responsibility procedures for that grant. The law allows grants from donor advised funds to all supporting organizations so long as expenditure responsibility procedures are followed.
What are the penalties?
If a taxable expenditure is made, the charity that administers the fund must pay a penalty equal to 20% of the expenditure. Further, any fund manager who agrees to make the distribution “knowing that it is a taxable distribution” must pay a
5% penalty. These penalties may be abated (excused) for good cause.
Who are fund managers?
A fund manager is an officer, director or trustee of the sponsoring organization. Also, any employee who has the authority or responsibility over any act (or failure to act) is a fund manager with respect to that particular act (or failure to act).
What is "expenditure responsibility"?
Expenditure responsibility is designed to ensure that a grant is used for a charitable purpose and that appropriate oversight and documentation of the grant is maintained. While the U.S. Department of Treasury has not yet issued any guidance as to the specific expenditure responsibility steps for public charities, the regulations for private foundations provide some guidance.
Expenditure responsibility as described for private foundations consists of five steps:
- Conducting a pre-grant inquiry including a reasonable investigation of the grantee to ensure that the proposed activity is charitable and that the grantee is able to perform the proposed activity.
- Executing a written agreement with the grantee that specifies the charitable purposes of the grant and includes provisions that prohibit use of the funds for lobbying activities and require the grantee to return any funds not used for the designated purposes.
- Requiring the grantee to maintain the grant funds in a separate fund so that charitable funds are segregated from non-charitable funds.
- Requiring the grantee to provide regular reports on the use of the funds and the charitable activity support by the grant.
- Including a report on Form 990-PF about the grant including a brief description of the grant, the amount, the charitable purpose and the current status of the grant.
Charities that make grants from donor advised funds to non-charities or affected supporting organizations for lobbying, nonpartisan voter registration activity or for regranting should consult with counsel as to how expenditure responsibility should be handled in those situations.
When did these rules take effect?
These rules became effective at the beginning of an organization’s first tax year after the date of enactment, August 17, 2006. For foundations with a calendar tax year, the rules took effect January 1, 2007.
Where can I find the rule?
Section 1231 of the Pension Protection Act of 2006 adds new section 4966 to the Internal Revenue Code. Regulations implementing this provision have not been issued.