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Reforming Distribution Requirements for Donor Advised Funds and Private Foundations

In the summer of 2021, The Accelerating Charitable Efforts (ACE) Act was introduced in the US Senate. The goal of the proposed legislation is to have the funds held within private foundations (PFs) and donor advised funds (DAFs) moved into the hands of charitable organizations faster. Individuals can then take advantage of the tax deductions to PFs and DAFs even though their donations are not going directly to working charities. The bill would impact individual donors, PFs, DAFs, and also public charities that receive donations from DAFs.

Impact on Donor Advised Funds

At issue with DAFs is the lack of a requirement for when the funds must be distributed to a public charity, unlike private foundations that must distribute 5% of assets annually. To address this, the Ace Act would divide DAFs into qualified and nonqualified funds (with a special exemption for DAFs held in certain community foundations). Qualified DAFs (Q-DAFs) would be required to distribute funds within 15 years of their contribution or have the donor’s privileges released, while Non-qualified DAFs (NQ-DAFs) would have 50 years. Sponsoring organizations will face an excise tax equal to 50% of the amount of the contribution and attributable earnings that have not been distributed.

Donors who contribute to a Q-DAF would still be able to immediately deduct contributions on their individual taxes, while contributions to a NQ-DAF would only be deductible when the funds are ultimately distributed by the DAF. Gifts of complex assets that cannot be readily valued would be deductible when the assets are sold by the DAF and cash proceeds are distributed (and the eventual deduction would be limited to the cash proceeds from the asset’s sale). Donors who contribute to a NQ-DAF, though not immediately deductible, would still be able to receive capital gains and estate tax benefits upon donation.

Community foundations (CFs) holding DAFs would be offered a limited exemption from these required distribution rules and different distribution requirements for those DAFs that are not exempted. Again, the legislation would divide CFs into Qualified and Non-qualified organizations. A qualified CF (Q-CF) must be a 501(c)(3), serve the needs of a geographic community that is not larger than 4 states, and whose total assets must exceed 25% from non-DAFs funds.

A DAF held at a Qualified Community Foundation will be exempted from required distribution rules if its value does not exceed $1 million, or the aggregate value of all DAFs held by one individual does not exceed $1 million. If the value exceeds $1 million, then it must distribute at least 5% of the DAFs assets annually, or distribute funds within 15 years of their contribution, to be a Qualified DAF.

Impact on Private Foundations

With respect to DAFs, the bill would no longer allow distributions to DAFs from PFs to count towards the PFs annual distribution requirement unless the DAF distributes those funds by the end of the following year.

PFs already have an annual distribution requirement for 5% of total assets, but this bill would offer an exemption from the 1.39% excise tax on investment earnings for any year when the organization distributes 7% or more.

PFs could also be exempt from the 1.39% excise tax if it is a “limited duration” private foundation, (which has a duration of 25 years or less specified in its governing documents) and it makes no distributions to other private foundations (other than limited duration PFs) which share a disqualified person in common.

Also, at issue with PFs (not specifically related to DAFs) are the salaries, travel, and administrative expenses deemed reasonable and necessary expenses of the foundation that count toward its annual distribution requirement but are paid to family members of disqualified persons. Under the act, such expenses would no longer count toward the annual distribution requirement, but administrative expenses paid to a foundation manager who is not a family member of a disqualified person would continue to count.

Impact on Public Charities

Working charities that receive contributions from DAFs may also be impacted by the Ace Act, which makes reforms to the reporting of DAFs on the Public Support Test (Schedule A of Form 990). Under current law, DAFs and sponsoring organizations are considered 501(c)(3) public charities and their contributions are thus excluded from consideration as excess contributors. The Ace Act would require that DAFs which identify the original donor would be aggregated with other donations received from that donor. If the original donor is not identified then, the organization must combine all the anonymous DAF contributions received from all sponsoring organizations and consider them to be received by a single donor, subject to the excess contributor rules.

However, if a sponsoring organization made a donation from its own funds (not from a DAF), this would continue to be considered as received by a 501(c)(3) public charity that is exempt from consideration as an excess contributor.

Organizations that receive a large amount of anonymous DAF gifts could see their public support percent drop if this becomes law. Public charities must keep their public support percent above 33.33% each year to maintain their tax-exempt status.  If this rule could jeopardize an organization’s public support test, it is recommended they request that sponsoring organizations identify the original donors.

Status of the Ace Act

The Ace Act was introduced in the summer of 2021 and was referred to the Committee on Finance. There has been no other action.

While the reforms in the bill have been called for by coalitions of philanthropic and nonprofit leaders to hasten access to hundreds of billions of dollars held in DAFs and PFs, sponsoring organizations and their advocates say that the regulatory requirements are too complex and would make administering DAFs too difficult, and thus reduce overall amount of giving.

Steve Taylor, Senior Vice President and Counsel for Public Policy at United Way Worldwide, believes the bill will not move forward because there are many important bills already in Congress, and because the nonprofit sector itself is not unified behind the bill.

If the Ace Act does fail to move forward, this will likely not be the last time these or similar reforms are considered.  Four years before the bill was introduced, the IRS released Notice 2017-13 stating that the agency was considering developing regulations to address the concerns of DAFs. The IRS has not taken further action since releasing the notice, but the Ace Act did attempt to move forward on DAF regulations, and the concerns around DAFs has not diminished.

For more information or to see how Windes can assist, please get in touch with Aaron Phillips at aphillips@windes.com or
844.4WINDES (844.494.6337).

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