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Donor Advised Funds

For many years, charitable organizations (referred to as "sponsoring organizations" throughout the nation have increased their use of donor advised funds to solicit charitable contributions. These funds have been used very successfully for a long period as "component funds" of community foundations (technically referred to as "community trusts").

Donor advised funds are very attractive to contributors, in that the donors:

  • may remain anonymous in making charitable gifts,
  • receive the maximum charitable contribution deductions allowable under the Internal Revenue Code,
  • are able to influence (but not mandate) the distribution of income and principal from their contribution to other charitable organizations in years to come, and
  • are not subject to the same burdensome requirements, excise taxes, and reporting requirements applicable to private foundations, or organizational constraints of supporting organizations (discussed elsewhere on this website).

Until passage of the Pension Protection Act of 2006 (PPA), neither the Internal Revenue Code nor the Income Tax Regulations defined a donor advised fund. Regrettably, restrictions have now been placed on donor advised funds as a result of abuse by donors and sponsoring organizations. As a result, that Act now defines a donor advised fund has having three specified criteria:

  • the donor advised fund must be solely owned and controlled by the sponsoring entity,
  • the assets in the fund must be sequestered and separated from the sponsoring organization's general fund and identified with reference to the contribution of a donor or donors, and
  • the donor or an appointed or designated advisor named by the donor must have, or reasonably expect to have, advisory privileges regarding the distribution or investment of assets held in the fund.

A donor advised fund does not include the following:

  • a fund or account that makes distributions only to a single, identified organization or government entity,
  • a committee-advised fund (a fund established exclusively for disaster relief or to benefit a single identified charitable purpose as established by Treasury regulations), or
  • a fund or account for which a donor provides advice as to which individuals receive grants for travel, study, or other similar purposes, except under certain conditions outlined below.

A donor advised funds may provide grants to individuals for travel, study, or other similar purposes provided:

  • the donor (or donor advisor) is part of a committee appointed by the sponsoring organization,
  • the donor does not control the committee (whether alone or in concert with related persons), and
  • the grants are awarded on an objective basis.

While not subject to the same excise taxes as a private foundation, the PPA enacted excise taxes applicable specifically to donor advised funds. An excise tax may now be levied on the sponsoring organization, and an additional tax can be imposed on any fund manager, for a distribution from a donor advised fund to any person for any purpose not specified in the applicable sections of the Internal Revenue Code. If a donor, donor advisor or related party provides advice on distributions that result (directly or indirectly) in more than an incidental benefit to that person or party, an excise tax of 125% of the benefit is imposed on both the advisor and the recipient of the distribution. Any fund manager that knowingly approves of such a distribution can also be taxed up to 10% of the distributed amount. The excess business holding rules applicable to private foundations are now made applicable to donor advised funds. Finally, any grant, loan, compensation, or similar payment from donor advised funds to donors, advisors, and related parties is considered an excess benefit transaction subject to penalty taxes provided in the Internal Revenue Code. In addition, a manager of the sponsoring organization that knowingly permits such a distribution is subject to a 10% penalty based on the value of the impermissible benefit.

Although a donor or donor advisor can recommend charitable distributions to the sponsoring organization, they can not mandate such distributions. In addition, a donor cannot satisfy a legally binding pledge with a distribution from his or her donor advised fund, nor can the donor direct distributions to a private foundation. The sponsoring organization must retain the right to control the donated property (including the right to sell and invest fund assets) and retain the right to reject the donor's advice concerning the timing or propriety of distribution from the fund.

A donor advised fund is typically set up with one or more irrevocable, outright charitable contributions of money or other assets to the charity. The gifts may be made either during the donor's lifetime or testamentary through the donor's will. Since the gift is an irrevocable, outright transfer of all interests in the money or property, the donor (or his estate) receives normal income tax and gift (or estate) tax deductions for the contribution. The donor has no retained interest in the contributed assets other than the right to advise as to ultimate charitable beneficiaries. Because the donor has no retained interests in the assets, a donor advised fund is not subject to the same restrictions and reporting requirements applicable to charitable remainder trusts, charitable lead trusts, or other types of "split-interest" gifts.

Charitable organizations can offer donor advised funds to their contributors as a charitable giving vehicle to meet a donor's objectives that cannot be met by other charitable giving alternatives. Even with the new restrictions imposed by the PPA, properly established and administered donor advised funds are an extremely beneficial charitable giving vehicle for your organization to offer. We have assisted charities in establishing donor advised funds that meet these requirements. We are available to help your organization establish a donor advised fund program.

©2008 Ronnie C. McClure, PhD, CPA