Comments Close on IRS' Excise Tax Plan for Donor-Advised Funds

The comment period closed Thursday on long-awaited proposed IRS regulations intended to curb the potential misuse of donor-advised funds, an increasingly popular charitable giving vehicle, by more broadly and vigorously enforcing the assessment of excise taxes on distributions that don’t actually end up going to charities.

Donor-advised funds, or DAFs, allow donors to set aside money for charity now and get the tax break up front. They money can then grow tax-free in the DAF before it is allocated to charitable causes down the line.

Summarized simply, the proposed rules are meant to discourage taxpayers from putting money into DAFs, letting it grow tax-free, and then later transferring the money to a non-charitable entity via a taxable distribution.

In November, the Treasury Department and Internal Revenue Service released the proposed regulations and called for comments by Jan.16. The comment deadline was then extended in early January.

Under the proposal, a 20% excise tax would be imposed on a sponsoring organization with respect to any taxable distribution from a donor-advised fund, and any fund manager that knowingly agrees to a taxable distribution would face a 5% excise tax.

As summarized in a detailed guide by lawyers with Ropes & Gray, the new proposed regulations tie back to the Pension Protection Act of 2006. They would generally apply to community foundations and other charitable organizations that maintain one or more donor-advised funds. There are also implications for others involved with the funds, including donors, donor-advisors, related persons and certain fund managers.

As the attorneys explain, a donor-advised fund is an account that is maintained by a qualified charitable organization, which is technically referred to as the “sponsoring organization.” Such DAFs are funded by contributions from individual or corporate donors who retain advisory privileges with respect to the distribution or investment of amounts in the fund.

Because the funds are sponsored by public charities, including the likes of Schwab Charitable and Fidelity Charitable, they have historically been able to offer many of the same benefits as private foundations without being subject to the restrictive private foundation rules.

According to the attorneys, the Pension Protection Act of 2006 added special rules enforced via excise taxes that govern transactions with and benefits received by donors, their advisors and certain other persons. Generally, the rules seek to discourage taxable distributions from the funds by making them costly for donors and sponsors, but there have been big questions for nearly two decades about how the rules actually apply.

In this context, a “taxable distribution” means “any distribution” from a donor-advised fund “to any natural person or to any other person if the distribution is for any purpose other than charitable purposes.” Taxable distributions can also occur if the sponsoring organization does not exercise “expenditure responsibility.”

As the Ropes & Gray attorneys summarize, the proposed regulations expand the statutory definition of a “distribution” (which includes any grant, payment, disbursement or other transfer from a donor-advised fund) by introducing the concept of a “deemed distribution.”

A deemed distribution is any use of fund assets that results in a more than incidental benefit to a donor, their advisor or a related person — as well as any expense charged solely to a donor-advised fund that is paid directly or indirectly to a donor or those close to them.

The proposed regulations expand upon interim IRS notices to provide clearer guidance on the interpretation of key definitional terms of the Pension Protection Act, clarifying the scope of accounts treated as donor-advised funds and the distributions constituting taxable distributions.

As the attorneys note, the proposed rules will “necessarily impact the application of other rules for DAFs,” so clients and advisors should take pains to understand exactly what is changing — even if they don’t expect to make taxable distributions.

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