Proposed Rule: Taxes on Taxable Distributions from Donor Advised Funds under Section 4966

Overview

On November 14, 2023, the U.S. Department of the Treasury (Treasury) and the Internal Revenue Service (IRS) released proposed regulations that would clarify how the Treasury and the IRS interpret rules governing donor advised funds (DAFs) under Section 4966. Specifically, the proposed rule provides definitions for key terms, including what qualifies as a DAF, who counts as a donor or donor-advisor, what constitutes advisory privileges, and what types of distributions are subject to the excise taxes provided under 4966. It also identifies categories of funds excluded from DAF classification (such as certain scholarship funds, certain disaster relief funds, and funds that name a single identified beneficiary). The Council submitted comments in response to the proposed rule in February 2024. Treasury and IRS have not yet finalized these regulations.

Definition of Donor Advised Fund Clarification

A donor-advised fund (DAF) or account is: 

1. Separately identified by reference to contributions of a donor or donors;
2. Owned and controlled by a sponsoring organization; and
3. At least one donor or donor-advisor has, or reasonably expects to have, advisory privileges with respect to the distribution or investment of amounts held in such fund or account by reason of the donor's status as a donor.

The proposed regulations clarify that a fund is considered separately identified if the sponsoring organization maintains a formal record of contributions by donor(s). If a formal record is not maintained, facts and circumstances may establish the fund is a DAF. These can include: 

• At least one donor receives an account or fund statement.
• The account balance reflects the contributions, dividends, distributions, expenses, gains & losses.
• A fund is named after a donor or related person.
• The sponsoring organization generally solicits advice before making a distribution. 

Exceptions to the Definition of a DAF

• Single Identified Organization: A fund only makes distributions to a single governmental entity or public charity (except disqualified supporting organizations). The fund also cannot make distributions to third parties on behalf of the organization.
• Multi-Donor Funds or Accounts: A multiple-donor fund or account would not be a DAF if no donor or donor-advisor has, or reasonably expects to have, advisory privileges with respect to the distribution or investment of funds in the account.
• Scholarship Funds or Accounts: A donor or donor-advisor may provide advice about grants for travel, study, or similar activities and the will not be considered a DAF as long as the person is providing advice in their capacity as a member of the selection committee; all members of the selection committee are appointed by the sponsoring organization; the donor or donors do not directly or indirectly have control over the selection committee; and all grants are awarded based on nondiscrimination criteria based on written procedures approved in advance. In addition, scholarship funds established by broad-based section 501(c)(4) organizations will not be considered DAFs if certain criteria are met.
• Disaster Relief Funds: Whether established by an employer or otherwise, funds that provide charitable assistance in qualified disasters and meet criteria established by the proposed regulations, such as a selection committee that is not controlled by a donor or related persons, objective criteria, and process to determine grants, among others. 

Definition of Donor

Any person described in section 7701(a)(1) that contributes to a fund or account of a sponsoring organization. A donor could be an individual, trust, private foundation, estate, partnership, association, company, or corporation.

Exceptions to the Definition of a Donor

• A governmental unit
• Most section 501(c)(3) public charities 

Definition of Donor Advisor

A person who establishes the fund or account and advises as to distributions or investments, or a person appointed or designated by the donor to have advisory privileges. Donor advisors could include: 

• A person who establishes a fund or account and advises on distributions or investments, regardless of whether they contribute monetarily to the fund.
• Advisory committee members recommended by a donor and appointed by the sponsoring organization may be donor-advisors, except as described above in the Advisory Committees section.
• An investment advisor that manages the investment or provides investment advice on both the assets maintained in a DAF and the personal assets of a donor to that DAF may be a donor-advisor while serving in that dual capacity, regardless of whether the donor appointed, designated, or recommended the personal investment advisor. The effect of this definition is that personal investment advisors cannot receive compensation from the DAF (under section 4958).

Exceptions for Donor Advisors 

• An investment advisor who is providing services to the sponsoring organization as a whole.
• Some advisory committees where a donor or donor-advisor is appointed to the committee are exempt if the following three conditions are met:
  • The donor or donor-advisor appointment is based on objective criteria;
  • The committee includes three or more individuals, and not more than one-third are related persons with respect to any of the other committee members; and
  • The appointee is not a significant contributor to the fund or account, considering contributions by related persons, at the time of appointment.

Clarification of Advisory Privileges

For a fund or account to be a DAF, at least one donor or donor-advisor must have or reasonably expect to have advisory privileges with respect to distributions from such account. Advisory privileges may exist even if no advice is given. The proposed rule provides a facts and circumstances test to determine that a donor has advisory privileges, regardless of whether they are exercised. The presence of any of the following four provisions may be sufficient to establish advisory privileges:

• The sponsoring organization allows a donor or donor-advisor to provide nonbinding recommendations regarding distributions or investments.
• A written agreement states that a donor or donor-advisor has advisory privileges.
• A written document or any marketing material from the sponsoring organization made available to a donor or donor-advisor indicates that a donor or donor-advisor may provide advice or recommendations.
• The sponsoring organization generally solicits advice from a donor or donor-advisor regarding distributions or investments. 

Exception for Advisory Privileges 

A donor or donor-advisor can recommend a person to serve as a member of an advisory committee of the sponsoring organization for the fund or account and not be a donor-advisor if: 

1. The recommendation is based on objective criteria related to the expertise of the member in the particular field of interest or purpose of the fund or account;
2. The committee consists of three or more individuals, and a majority of the committee is not recommended by the donor or donor-advisor; and
3. The recommended person is not a related person with respect to the recommending donor or donor-advisor. 

Definition of Distribution

Defines a distribution as any grant, payment, disbursement, or transfer from a DAF. Distributions do not include investments or grant-related fees.  

• For grants to foreign charities, DAFs can use the same equivalency determination procedures as private foundations.  

Taxable Distribution: A taxable distribution would include distributions to a person not for a charitable purpose or if the sponsoring organization fails to exercise expenditure responsibilities. In addition, any distribution that provides more than an incidental benefit to the donor, donor-advisor, or related persons would be considered a taxable distribution. An excise tax of 20 percent on the sponsoring organization and 5 percent on fund managers who knowingly agree to a taxable distribution would also apply.

Impact on Philanthropy

If finalized as proposed, community foundations and other sponsoring organizations may need to reassess how they structure funds, engage donors and advisors, and approve grants. The proposed regulations could expand the number of funds that must be classified as a DAF, subjecting more sponsoring organizations and their advisors to greater compliance obligations and excise tax exposure. The broad definition of “donor-advisor,” which could sweep in personal investment advisors who also manage DAF assets, would restrict compensation arrangements that are currently common practice. The facts and circumstances test for advisory privileges could also pull funds not previously considered DAFs into the scope of the DAF regulations. Together, these provisions would increase administrative burden on sponsoring organizations and create legal uncertainty and risk for donors and advisors.