Key Provisions of Proposed Donor-Advised Fund Regulations

The IRS released proposed treasury regulations (REG-142338-07) on November 13, 2023. These regulations provide guidance on how to interpret IRC Section 4966 regarding the excise taxes on distributions from a donor-advised fund (DAF) as well as other DAF tax rules.

Here is a breakdown of the key provisions and implications of the proposed regulations.

Definition of a Donor-Advised Fund

IRC Section 4966 specifies three key criteria for characterizing a DAF.

A DAF is defined as a fund or account that:

1. Is distinctly identified by contributions from one or multiple donors.
2. Is owned and controlled by a sponsoring entity.
3. Grants at least one donor or donor-advisor the authority, or expectation thereof, to advise on the distribution or investment of funds or assets.

New Definitions Per Proposed Regulations

Donors

The proposed regulations explain that a donor is generally any individual identified in section 7701(a)(1) who contributes to a fund or account managed by a sponsoring organization.

The term "donor" does not include:

• Any public charity as defined in section 509(a)(1), (2), or (3), except for those that are disqualified supporting organizations.
• Any governmental entity specified in section 170(c)(1).

This means a fund or account specifically funded by these exempt entities' contributions is not considered to be funded by donor contributions and, therefore, would not be considered a DAF.

Donor-Advisors

Section 4966(d)(2)(A)(iii) defines a donor-advisor as a person appointed or designated by a donor to have advisory privileges regarding the distribution or investment of assets held in a fund or account of a sponsoring organization.

The proposed regulations introduce specific guidelines for identifying donor-advisors, summarized as follows:

• Any individual who sets up a fund or account and advises on its distributions or investments, even if they do not contribute financially to the fund.
• Investment advisors who provide investment management services to both DAF assets and a donor's personal assets. This classification does not depend on whether the donor had a role in appointing the advisor, though an exception exists if the investment advisor is primarily serving the sponsoring organization as a whole.
• Advisory committee members — i.e., individuals recommended by a donor and appointed by the sponsoring organization to an advisory committee. An exception may be made if the individual is recommended based on expertise in a particular field of interest to the DAF.

Advisory Privileges

The proposed regulations provide four specific conditions that would establish a donor or donor-advisor as having advisory privileges in relation to the fund, even if such advice is not followed.

These conditions are:

1. The sponsoring organization permits a donor or donor-advisor to suggest, without obligation, how the funds or assets should be distributed or invested.
2. A written agreement exists granting advisory rights to a donor or donor-advisor.
3. Any written material or marketing documents provided to a donor or donor-advisor by the sponsoring organization suggest that they may offer such advice.
4. The organization regularly seeks input from a donor or donor-advisor on how to oversee the funds.

Exceptions to the Definition of Donor-Advised Funds

The proposed regulations provide two exceptions to the definition of DAFs.

Single Identified Organization

A fund or account will not be considered a DAF if it is established to make distributions solely to a single identified organization that is either:

1. An organization such as a corporation, trust, community chest, fund, or foundation that is organized and operated for charitable, religious, scientific, literary, or educational purposes.
2. A governmental entity such as a State, a possession of the United States, or any political subdivision of any of the foregoing, or the United States or the District of Columbia.

Notably, this exception does not apply if the single identified organization is a private foundation, disqualified supporting organization, foreign organization, or non-charitable organization.

Statutory Scholarship Exception

Proposed regulations, consistent with section 4966(d)(2)(B)(ii), provide that the term “donor-advised fund” does not include a fund or account that exclusively makes grants for travel, study, or other similar purposes, provided certain requirements of paragraph (1), (2), or (3) of section 4945(g) are met.

Additionally, the proposed regulations provide two additional exceptions to the definition of DAF under section 4966(d)(2)(C):

• An employer-sponsored or a non-employer disaster relief fund if the requirements of section 139 are met. The exception does not apply to emergency hardship funds.
• Specific scholarship funds managed by a committee chosen by a section 501(c)(4) organization with broad-based membership.

Taxable Distributions

The proposed regulations introduce an anti-abuse rule. This rule establishes that if multiple distributions are made in a way that goes against the goals of section 4966, they will be treated as one single distribution. If DAF assets are used in a way that gives significant benefits to a donor, donor-advisor, or someone related to them, they will be considered a taxable distribution under section 4967.

However, the proposed regulations clarify that investments and reasonable fees related to managing investments and grants are usually not seen as distributions, except when they result in significant benefits.

Next Steps for Donor-Advised Fund Regulations

The suggested changes to DAF regulations aim to clarify and refine the guidelines to improve transparency, accountability, and operational efficacy. However, they also sparked considerable debate and concern among various sectors, including philanthropic organizations, financial advisors, and sponsoring organizations.

As regulations develop, it is critical to thoroughly examine changes to ensure the final rules strike a balance between encouraging charitable contributions and upholding regulatory control. We will keep a close eye on these updates and share more relevant details as they become available. If you would like to discuss how the proposed regulations might affect your funds or programs, we’re here to help.