Accelerating Charitable Efforts Act and Two High Profile Charitable Vehicles
By Michaela Cromar and Laura J. Kenney
There are two charitable contribution vehicles that have been driving a great deal of controversy in the philanthropic and tax worlds lately: donor advised funds and private foundations.
Donor Advised Funds – Warehousing or Green Housing?
Critics of donor advised funds call it “warehousing” of charitable contributions; proponents of donor advised funds call it “green housing.” Recent proposed legislation, entitled “Accelerating Charitable Efforts Act” or the “ACE Act”, a bipartisan bill introduced on June 9, 2021, is an attempt to rein in some perceived excesses and to accelerate charitable granting.
Donor advised funds (DAFs) are held by a sponsoring public charity that generally allows donors to make grant and investment recommendations for the amounts they’ve donated to the sponsoring charity. Many of these are charities set up by financial institutions, community foundations and other sponsoring charities that run successful DAF programs.
Sponsoring organizations technically have exclusive legal control over all of their funds. They allow donors to make recommendations for charitable grants from their DAFs to qualified public charities over time, but the sponsoring organizations have the final say.
DAFs were already wildly popular with wealthy donors and have become even more widely used by a broader group of donors, in particular because of tax reform legislation that increased the standard deduction for individual taxpayers. Taxpayers can use DAFs to bunch their charitable contributions in one year, thereby receiving tax benefits for their charitable donations. They have been very useful for taxpayers who would have otherwise just been limited to the standard deduction if they spaced out their contributions over multiple years rather than bunching them into one year.
Private foundations can also be used for bunching donations. They may pay out grants over time, too, but private foundations have specific grant distribution requirements that must be made annually. DAFs currently have no distribution requirements for tax purposes at all.
The proposed legislation would change that by putting timelines on the donors’ advisory privileges.
Qualified DAFs and Nonqualified DAFs
Under the proposed legislation, DAFs would be considered either qualified or nonqualified. Qualified DAFs would terminate the donor’s advisory privileges after 15 years. Donors would need to identify upfront their preferred charity for the sponsoring charity to make distributions to if their DAF funds were not all granted out to charities by then.
Nonqualified DAFs would terminate after 50 years. They would also be subject to four restrictions that would not apply to Qualified DAFs:
- Noncash contributions would not be deductible for the donor until the sponsoring organization sells the contributed asset for cash and makes a qualifying distribution of the cash.
- Donors to nonqualified DAFs would only get a deduction for their donation in the year the sponsoring organization makes a qualifying distribution of that contribution or the proceeds of the sale of the noncash contribution.
- The amount of the donor’s deduction would be limited to the amount of the qualified distribution.
- Contributions must all be distributed within the 50-year life of the DAF.
Obviously, the definition of a “qualifying distribution” will be critical. The proposed legislation defines it as:
- A distribution made to a stand-alone public charity, not to another DAF and
- one that is not a taxable expenditure under §4966(c), which spells out the excise tax rules for taxable distributions on DAF sponsoring organizations.
In the case of a lag between contributions to the DAF and a qualified distribution, the qualifying distribution will be assigned to contributions and their earnings on a first-in, first-out basis.
To be sure that contributions are actually made, there would be a 50% tax on the DAF, including any contribution and its earnings, for remaining amounts that are not granted to qualifying grantees within 6 months of the applicable periods, 15 years for qualified DAFs or 50 years for nonqualified DAFs.
Qualified Community Foundation Donor Advised Funds
The ACE Act defines a qualified community foundation as a public charity with a mission of understanding and serving the needs of a particular geographic community of up to four states. It engages donors and pools donations to serve that community and holds at least 25% of its assets outside of donor advised funds.
A qualified community foundation DAF is one that is owned or controlled by a qualified community foundation that meets at least one of the two following tests:
- an individual with advisory privileges over the DAF does not have advisory privileges with respect to 1 or more DAFs held by the qualified community foundation with an aggregate value over $1,000,000, (adjusted each year after 2021 for inflation), or
- the fund is required to make qualifying distributions each year of at least 5% of the value of the fund.
How Would ACE Affect Donors?
Donations of “nonpublic traded assets” to qualified DAFs or to qualified community foundations would only be eligible for charitable contribution tax deductions in the year that the sponsoring organization sells the asset. The donation would be limited to the gross proceeds received from the sale and credited to the donor’s DAF.
Donations of noncash gifts to nonqualified DAFs would only be deductible if the sponsoring organization sells the property for cash and makes a qualifying distribution of such contribution and no contributions would be deductible before the tax year that the sponsoring organization makes a qualifying distribution of that contribution (or the proceeds from the sale of that contribution). The deduction would be limited to the amount of the qualifying distribution.
Donors would need to obtain contemporaneous written acknowledgements from the sponsoring organization that includes:
Qualified DAFs:
- name of the donor
- certification that the asset was sold
- the amount of the gross proceeds from the sale and
- the amount credited to the DAF
- a statement, within 30 days of the gross proceeds credited to the DAF, that the deductible amount may not exceed the gross proceeds credited to the DAF
Nonqualified DAFs
- name of the donor
- certification that the asset was sold for cash
- the amount of the cash received in the sale and
- certification that a qualifying distribution was made from the contribution (or the proceeds from the sale of the contribution)
- identification of the amount of the qualifying distribution
- a statement, within 30 days of the qualifying distribution, that the deductible amount may not exceed the amount of the qualifying distribution
The sponsoring organization would need to send these acknowledgments to the Internal Revenue Service (IRS) as well, which would be a new tax filing requirement.
Interplay between DAFs and Public Charities
The current tax rules allow grants from the sponsoring organization of DAFs to be considered public support to the grantees because the sponsoring organization itself is a public charity. A public charity is generally one that receives at least one third of its support from the public and governmental entities, rather than from a limited number of donors. Support from most types of public charities to another public charity is normally considered to be public support. The proposed bill would not allow DAF grants to be considered public support; rather it would consider the support to be from one person, the sponsoring charity – even if they were from multiple DAFs of that sponsoring organization.
However, if the DAF contribution to a public charity is identified with a particular donor, and the sponsoring organization identifies the donor, that contribution would be considered to be support from that donor. Excess contributions, that is, contributions more than two percent of the organization’s total support during the period, from any one donor (aggregated with contributions from his or her family and related entities) are excluded from the numerator in the public support test. In certain cases, this could cause the recipient organization to fail the public support test and lose its public charity status. This is meant to prevent the potential abuse, as highlighted previously by the IRS, of donors circumventing the private foundation rules by advising distributions from a DAF to a charity.
There would be an exception to these rules if the sponsoring organization stated that the donation was not from any DAF and that no donor (or person appointed by the donor) had advisory privileges with respect to that grant.
Interplay between DAFs and Private Foundations
A few years ago, IRS notice 2017-73 had requested comments on various private foundation and donor advised fund issues including how private foundations use donor advised funds in support of their purposes and if a private foundation should be allowed to treat a grant to a DAF as a qualifying distribution only if the sponsoring charity of the DAF paid it out to other charities within a certain timeframe.
The proposed ACE Act would no longer allow private foundations to treat a distribution to a sponsoring organization of DAFs as a qualifying distribution, unless that distribution was also distributed to a qualifying public charity by end of the following tax year and reported as such. The private foundation’s Form 990-PF would need to include the amount of any contribution to a sponsoring organization to be held in a DAF, the name of the sponsoring organization and the donation advice, if any, given to the sponsoring organization.
The Carrot for Private Foundations
The proposed legislation includes some provisions to incentivize private foundation managers to accelerate charitable grant-making. One of these incentives is to provide an exemption from the 1.39% excise tax on net investment income if the private foundation makes qualifying distributions during the tax year of at least 7% of the fair market value of the foundation’s assets.
The other incentive is to provide an exemption from the net investment excise tax if the private foundation is a “limited-duration” private foundation that makes no distributions to any disqualified private foundations and specifies in its governing documents that it has a duration period of no more than 25 years.
The Stick
The ACE Act would not allow administrative expenses paid to family disqualified members, such officers, directors, trustees to be treated as qualifying distributions for a private foundation’s annual distribution requirement.
Conclusion
Many of these provisions were previously suggested in late 2020 by a coalition of influential philanthropists and major foundations on their Initiative to Accelerate Charitable Giving website as we reported in our client alert: IRS 2021 Plan Highlights Focus on Private Foundations : 2021 : Articles : Resources : CLA (CliftonLarsonAllen) (claconnect.com)
Critics of the ACE Act believe these provisions will increase the administrative burdens for charitable giving and will hamper charitable efforts; proponents of the Act believe these provisions will encourage funds to be granted from sponsors of DAFs and private foundations and to be put to use more quickly for charitable purposes.
No matter at what destination the Accelerating Charitable Efforts bipartisan proposed legislation arrives, it has definitely been accelerating charitable discussions along the way.
Laura enjoys providing tax services for public charities, higher education institutions, private schools, cultural institutions, associations, foundations and healthcare organizations.
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