What the Treasury Department Gets Right (and the Congressional Research Service Gets Wrong) About Donor-Advised Funds
When I was studying nonprofit law in my student days, donor-advised funds (DAFs) were a major topic of conversation. For those not familiar, a DAF is a fund managed under the auspices of a qualified charity that receives the money as a tax-deductible donation and holds it to be distributed to active charities at some future time at the direction of the donor. Technically, though, the fund’s sponsor is under no obligation to follow the donor’s directives. It is something of a gentleman’s agreement.
This arrangement rubs many people the wrong way. It rubbed me the wrong way the first time I encountered it, for a variety of reasons. Partly because I was still a law student with a head full of technicalities about what is and isn’t a “good” (i.e. unambiguously assigned) gift. It bothered me that money that was ostensibly being donated to a qualified charity remained in de facto control of the donor, particularly as there was (and is) no requirement as to when the money actually begins supporting some charitable purpose. My view was that charitable donations must 1) be donated, and 2) to a charity, for it to be a charitable donation. You can’t leave your finger on the chess piece indefinitely. To get your deduction, you must actually have done something. And the wink-and-nod relationship between the (IRS-qualified) fund sponsor and the (usually) wealthy donor seemed a little seedy, as if it somehow eroded the legitimacy of the entire philanthropic enterprise. Making matters worse, since DAFs were sponsored by charities, the tax treatment was more favorable than if the money had been donated to a private foundation, which the DAF in some sense replaced. I wrote a paper on the subject. I don’t still have a copy, but I assume it was an exercise in mild outrage based on the above points.
A few years later, I was asked by an old law professor to contribute a few paragraphs to a white paper on the subject. The matter was up before Congress again, which has taken an intermittent and mostly hostile interest in DAFs over the last couple decades. Again, I can’t lay my hands on what I wrote, but I imagine it was much the same, but dryer.
Since then, my views have moderated and I have come to think of the ambiguous status of DAFs as a potential good.
In fact, it is a bit surprising that DAFs have escaped regulation as much as they have. It was only in 2006 that Congress mandated basic reporting from DAFs. At the same time they directed the Treasury Department to study the new data with an eye toward regulating them in a similar way to private foundations. In 2011, to the annoyance of those who had ordered the report, the Treasury Department suggested doing nothing, saying that since the donor had technically relinquished control of the funds to the sponsoring organization, that pretext (my word) was good enough for them. This despite the fact that everything in their report preceding their (non-)recommendation pointed to the fact DAF sponsors do behave as if the funds were still in the control of the donor. Many people were unhappy.
As an aside, I find it odd that the Treasury Department, which is more often involved with crimes tending toward the destabilization of the financial system, was tasked with investigating this piece of philanthropic tax-deduction arcana. In light of their usual role, I find their ‘personally, we really don’t care’ conclusion to their report pretty unsurprising, and I wonder why the IRS wasn’t given the assignment. I have my suspicions, but at this point it really doesn’t matter.
And there the matter has largely rested, to the annoyance of many on the Hill and in the IRS. The Congressional Research Service, a venerable non-partisan research and analysis division of the Legislative branch, has little good to say for DAFs, most recently in a June, 2022 report (extensively citing research from my alma mater). It mostly reiterates the points I made above, as well as the lack of detailed reporting requirements and the growth of DAFs as a proportion of charitable giving. The tone of this and previous CRS reports is that DAFs are ripe for legislation.
The CRS analysis is sound (go, Eagles, after all), but I happen think it is partially incomplete in certain respects. However, the compared to the IRS, the tone of the CRS report is one of tranquil benignity. Presumably operating from the same data, the IRS’s webpage’s brief statement on DAFs is overtly peevish:
“The IRS is aware of a number of organizations that appeared to have abused the basic concepts underlying donor-advised funds. These organizations, promoted as donor-advised funds, appear to be established for the purpose of generating questionable charitable deductions, and providing impermissible economic benefits to donors and their families (including tax-sheltered investment income for the donors) and management fees for promoters.”
Nothing is cited in support of these statements, the actions they threaten are for generic misdeeds, and the ominous “New requirements for donor-advised funds” link below their warnings simply refers to the 2006 legislation, and, amusingly, to the 2011 Treasury report. As I said at the top, something about these funds just rubs people the wrong way.
Personally, I think it would be a mistake to change the treatment of DAFs, apart from doing away with the ridiculous fiction that the funds are really in control of the sponsoring organization. My reasons are partly historical, based on the change in behavior of private foundations when they came in for annual payout requirements, and partly based on the positive good of having a variety of funding dynamics supporting the nonprofit sector. I will explore these more in part 2 of this blog post.