Legal Background on the Charitable Purpose of Donor Advised Funds

Donor advised funds are specifically defined in Section 4966(d)(2) of the Internal Revenue Code as a “fund or account

1. which is separately identified by reference to contributions of a donor or donors,
2. which is owned and controlled by a sponsoring organization, and
3. with respect to which a donor (or any person appointed or designated by such donor) 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.” 26 USCA 4966(d)(2).

This definition has been in place since the Pension Protection Act of 2006. Pursuant to Section 4966(d)(2)(ii), one of the key requirements for a donor advised fund is that the fund must be owned and controlled by a sponsoring organization. “Sponsoring organization” is defined in Section 4966(d)(1) as “any organization which (A) is described in section 170(c) (other than in paragraph (1) thereof, and without regard to paragraph (2)(A) thereof), (B) is not a private foundation (as defined in section 509(a)), and (C) maintains 1 or more donor advised funds. 26 USCA 4966(d)(1).

Organizations described in Section 170(c) by definition qualify for the charitable deduction under the Code as charitable organizations. See 26 USCA 170(c). Charitable organizations must be organized and operated exclusively for charitable purposes pursuant to Section 501(c)(3) of the Code. See 26 USCA 501(c)(3).

Consequently, organizations that meet the Section 4966(d)(1) definition of “sponsoring organization” must be exclusively charitable organizations that are not private foundations, and hold 1 or more donor advised funds.

The term “owned and controlled” in connection with a sponsoring organization is also a critical element of the donor advised fund definition. A donor who makes a contribution to a donor advised fund receives a charitable deduction in exchange for giving up legal ownership and control over the contributed assets to the sponsoring organization. In fact, a statement that the sponsoring organization maintains sole legal ownership and control over the assets must be provided by the sponsoring organization to all donors for contributions to donor advised funds. See Questions 5-6, Schedule D, IRS Form 990.

Therefore, because sponsoring organizations receive sole legal ownership and control of assets gifted to donor advised funds, and because sponsoring organizations must apply their assets solely to charitable purposes, the assets held in donor advised funds must also be used solely for charitable purposes.

The information is not a substitute for expert legal, tax or other professional advice and we strongly encourage grantmakers and donors to work with their counsel to determine the impact of this legislation on their particular situations. This information may not be relied upon for the purposes of avoiding any penalties that may be imposed under the Internal Revenue Code.