IRS proposes major changes for donor-advised funds

June 15, 2024 | by Atherton & Associates, LLP

Donor-advised funds (DAFs) have steadily grown in popularity as a strategic way to manage charitable giving. In late 2023, the IRS proposed new regulations governing DAFs that could impact many existing funds. 

These rules aren’t set in stone yet, but their potential to apply retroactively makes it crucial to understand the core concepts now. In the meantime, taxpayers can continue to rely on the existing rules, but out of an abundance of caution, it makes sense to prepare for the impending changes. 

While several questions remain unanswered and further clarification is expected, we’ll provide a foundational overview of the proposed regulations to date. 

Evolution of DAFs

DAFs are a popular tool for charitable giving, allowing individuals and entities to donate to a fund managed by a public charity and, in turn, receive immediate tax benefits. The donors also retain advisory rights on how their donations are distributed and invested.

The concept of DAFs dates back to the 1930s, but their popularity surged in the 1990s. By 2022, these funds accounted for over 10% of all charitable giving in the U.S., with grants from DAFs surpassing $52 billion. 

It was only in 2006, however, that DAFs were formally recognized by the Internal Revenue Code. The lack of clear regulations led to varied interpretations and inconsistencies in administration. 

Proposed regulations

In November 2023, the IRS unveiled a set of proposed regulations that aim to provide a clearer operational blueprint for DAFs. These proposed changes, while not final, provide a glimpse into the future landscape of DAFs. The proposals still leave some questions unanswered, but they generally modify the definitions of eligible funds, donors, and donor-advisors.

The proposed regulations expand the definition of a DAF, considering factors beyond formal documentation, such as the fund’s financial activities and the sponsoring organization’s practices with donors. They also redefine a donor as any entity contributing to a fund but explicitly exclude public charities and governmental entities. A fund that received contributions solely from either of these entities would not be considered a DAF. 

The role of donor-advisors is also clarified, with the proposed regulations stating that anyone with authority over a DAF’s distributions or investments is considered a donor-advisor. This includes personal investment advisors who manage both the assets of a DAF and those of a donor, a designation that could have significant tax repercussions. Notably, an investment advisor is not considered a donor-advisor if their advisory services extend to the sponsoring organization as a whole rather than being limited to specific DAFs. If an advisor provides personal investment advice for a specific DAF, compensation paid to the advisor will be considered an automatic excess benefit transaction subject to excise taxes. 

Implications

It’s important to recognize that these guidelines are preliminary and subject to refinement. Despite their proposed status, the implications are potentially significant, so it’s wise to take a proactive stance in anticipation of the impending changes. 

While these regulations are still provisional, they will extend retroactively to the entirety of the tax year in which they are finalized. Should the regulations become official anytime in 2024, they would apply to the entire 2024 tax year. This potential retroactivity underscores the importance for sponsoring organizations to reassess their policies and donor lists promptly. 

To prepare for the upcoming changes, sponsoring organizations should conduct thorough reviews of their existing funds. This can help them determine if other charitable funds will now be considered DAFs. For instance, field of interest funds or fiscal sponsorship arrangements may now be recognized as DAFs if the donor has advisory privileges regarding distributions. 

The changes to the definition of a donor-advisor deserve careful review and planning. If an investment advisor provides personal investment guidance for specific DAFs (as opposed to guidance for the sponsoring organization as a whole), the fund could face hefty excise taxes on the distribution. The advisor could also be required to correct the excess benefit transaction by returning the compensation, with interest, to the sponsoring organization. If not corrected, the advisor could face an additional tax of 200%. As such, sponsoring organizations that permit a donor to recommend an advisor for their DAF need to exercise caution, especially if that advisor also manages the personal assets of the donor. 

Additionally, the proposed regulations extend the scope of eligible distributions to include payments for services necessary to carry out an organization’s charitable purposes. For instance, a DAF may make a direct payment to a service provider for services performed on behalf of the charitable entity. However, the sponsoring organization should maintain thorough documentation showing that the direct payment was non-taxable. 

Preparing for the future

The proposed regulations are awaiting public comment before finalization, and it’s likely that more guidance will follow. In the meantime, sponsoring organizations should meet with legal and tax professionals to prepare for the upcoming changes. These professionals can help you understand the new regulations and revise your policies to ensure compliance.

Please note that this article provides a brief overview of the IRS’s proposed regulations and is not intended as legal advice. Many questions remain unanswered, and the regulations could be subject to change. Consider this overview as a starting point for a more in-depth exploration with your advisors. 

If you have any questions or would like personalized guidance, please contact our office.