- Forms, Rates & Tables
- Continuing Professional Education
- Determination Letter
- Email Chief Counsel Advice
- Exempt Organizations Update
- Field Service Advice
- Forms and Instructions
- General Counsel Memoranda
- IRS Announcements
- IRS Fact Sheet
- IRS Forms
- IRS Legal Memoranda
- IRS Notices
- Information Release
- Internal Revenue Code
- Letter Rulings
- Revenue Procedures
- Revenue Rulings
- Technical Advice Memoranda
- Treasury Decisions
- Income Tax
- Transfer Taxes
- Case Studies
- Technical Reports
Charitable Giving With Donor Advised Funds - Part I
The use of donor advised funds has increased dramatically in recent years, making them one of the more popular vehicles for making charitable contributions. Their increased popularity has also caused increased scrutiny that may ultimately lead to more regulation. In this first part of a two part article, PGDC's legal editors provide an overview of donor advised funds, including what they are and how they are being used.
Marc D. Hoffman
Editor in Chief
Planned Giving Design Center
Click here for Part II of this article.
The use of donor advised funds has increased in recent years, making them one of the more popular vehicles for making charitable contributions. Their increased popularity has also caused increased scrutiny that may ultimately lead to more regulation. This first part of a two part article will provide an overview of donor advised funds, including what they are and how they are being used. Then, the second part will look at some proposed legislation.
Donor Advised Funds - the Basics
There is no specific definition of a donor advised fund in the Code.1 Donor advised funds originated with and are similar to the component funds long used by community foundations but, as the use of donor advised funds has expanded to other types of charities, including those with a national donor base, it is not clear whether donor advised funds are subject to the same rules as traditional component funds.2 References to donor advised funds are found in several private letter rulings.3 A review of some of these private letter rulings as well as a few cases may be useful in trying to understand donor advised funds. However, before delving into the specifics of these rulings, a little background information on these other types of funds is necessary for an understanding of the distinctions between donor advised funds, component funds, and pooled common funds (sometimes referred to as donor directed funds).
A donor advised fund is an agreement between the donor and a charity that gives the donor the right to advise the charity on how a portion of the donor's contributions to the charity will be distributed to other charities. The donor may give the advisory rights to other people, such as family members. To fund the donor advised fund, the donor makes one or more irrevocable, outright charitable contributions of money or other assets to the charity. If a gift is made to the charity during the donor's life, the donor is entitled to an immediate income tax charitable deduction subject to the percentage limitation and reduction rules under Code Section 170. The donor is also entitled to a gift tax charitable deduction under Code Section 2522 for lifetime gifts, although it will not be necessary to report the gift on a gift tax return if it meets the requirements of Code Section 6019.4 A gift made at death would entitle the donor's estate to an estate tax charitable deduction under Code Section 2055. Typically, the donor has the right to name his or her donor advised fund, thus providing some ongoing name recognition to the donor or the donor's family.
Background - Public Charity v. Private Foundation
When an individual donor makes contributions to a charitable entity described in Code Section 170(b)(1)(A), the donor may generally deduct the contribution for income tax purposes to the extent the contribution does not exceed 50% of the donor's contribution base. A 30% limitation applies for contributions to other types of charitable entities not described in Code Section 170(b)(1)(A). The former type of charities, most of which are classified as public charities under Code Section 509, are sometimes referred to as "50%-type charities," while the latter type, which are classified as private foundations under Code Section 509, are sometimes referred to as "30%-type charities."
In addition to the less favorable percentage limitations on income tax charitable deductions, various private foundation excise taxes apply to charities classified as private foundations. These excise taxes do not apply to public charities because they generally receive broader support; thus, there is less concern about the influence that one person or family can have on them.
Pooled Common Fund
One subset of the 50%-type charities are those private foundations defined in Code Section 170(b)(1)(E), 5 including a type of charity known as a pooled common fund as described in Code Section 170(b)(1)(E)(iii). These pooled common funds are sometimes referred to as donor directed funds. One should keep in mind the differences between donor advised funds and these statutorily defined pooled common funds. Code Section 170(b)(1)(E)(iii) reads as follows:
[A] private foundation all of the contributions to which are pooled in a common fund and which would be described in section 509(a)(3) but for the right of any substantial contributor (hereafter in this clause called "donor") or his spouse to designate annually the recipients, from among organizations described in paragraph (1) of section 509(a), of the income attributable to the donor's contribution to the fund and to direct (by deed or by will) the payment, to an organization described in such paragraph (1), of the corpus in the common fund attributable to the donor's contribution; but this clause shall apply only if all of the income of the common fund is required to be (and is) distributed to one or more organizations described in such paragraph (1) not later than the 15th day of the third month after the close of the taxable year in which the income is realized by the fund and only if all of the corpus attributable to any donor's contribution to the fund is required to be (and is) distributed to one or more of such organizations not later than one year after his death or after the death of his surviving spouse if she has the right to designate the recipients of such corpus.
In other words, a pooled common fund is a special type of private foundation that is treated as if it were a public charity for purposes of the percentage limitation and reduction rules on income tax charitable deductions.6
The other type of fund that needs to be analyzed in order to have a full understanding of donor advised funds is the component fund traditionally used by community trusts. A community trust is a type of public charity described in Code Section 170(b)(1)(A)(vi), or in common parlance, a publicly-supported 50%-type charity. Community trusts are also commonly referred to as community foundations.
Specifically, this Code Section describes a charity that is "referred to in subsection (c)(2) which normally receives a substantial part of its support (exclusive of income received in the exercise or performance by such organization of its charitable, educational, or other purpose or function constituting the basis for its exemption under section 501(a)) from a governmental unit referred to in subsection (c)(1) or from direct or indirect contributions from the general public...."
Code Section 170(b)(1)(A)(vi) (publicly-supported, 50%-type) charities are further defined in Treasury Regulation Section 1.170A-9(e). Community trusts, a subset of this category, are discussed in Treasury Regulation Section 1.170A-9(e)(10).
Regulation Section 1.170A-9(e)(10) notes, "Community trusts have often been established to attract large contributions of a capital or endowment nature for the benefit of a particular community or area, and often such contributions have come initially from a small number of donors. While the community trust generally has a governing body comprised of representatives of the particular community or area, its contributions are often received and maintained in the form of separate trusts or funds, which are subject to varying degrees of control by the governing body." The Regulation goes on to explain what a community trust needs to do to qualify as a public charity.
Treasury Regulation Section 1.170A-9(e)(11) provides the rules governing the extent to which separate trusts or funds may be treated as component parts of a community trust, thereby allowing the community trust to meet the requirements for qualification as a public charity. If a fund of a community trust does not meet the requirements for component fund status contained in this Regulation, the fund will then be treated as a separate trust or non-profit entity rather than as part of the community trust,7 and will constitute a private foundation. In addition, the community foundation or trust may constitute an aggregation of separate funds and will not qualify as a publicly supported charity.
The requirements for component fund treatment are that the fund be created by a gift, bequest, legacy, devise, or other transfer to a community trust which is treated as a single entity under this Regulation and that the fund is not directly subject to any material restriction or condition by the transferor.8 Additional requirements are, among other things, that all funds of the community trust be subject to a common governing instrument 9 and that the community trust prepare periodic financial reports treating all of its component funds as funds of the organization.10
Material Restrictions or Conditions
Material restrictions or conditions are defined in Treasury Regulation Section 1.507-2(a)(8). If the transferor is not a private foundation, the transferor is treated as if he or she were a private foundation for purposes of the factors in Treasury Regulation Section 1.507-2(a)(8).11 This Regulation lists the following as some of the more significant facts and circumstances to be considered:
(A) Whether the public charity (including a participating trustee, custodian, or agent in the case of a community trust) is the owner in fee of the assets it receives from the private foundation;
(B) Whether such assets are to be held and administered by the public charity in a manner consistent with one or more of its exempt purposes;
(C) Whether the governing body of the public charity has the ultimate authority and control over such assets, and the income derived therefrom; and
(D) Whether, and to what extent, the governing body of the public charity is organized and operated so as to be independent from the transferor.12
The Regulation then goes on to list the following as non-adverse factors in determining whether the charity is prevented "from freely and effectively employing the transferred assets, or the income derived therefrom, in furtherance of its exempt purposes (within the meaning of paragraph (a)(8)(i) of this section):"
(A) Name. The fund is given a name or other designation which is the same as or similar to that of the transferor private foundation or otherwise memorializes the creator of the foundation or his family.
(B) Purpose. The income and assets of the fund are to be used for a designated purpose or for one or more particular section 509(a)(1), (2), or (3) organizations, and such use is consistent with the charitable, educational, or other basis for the exempt status of the public charity under section 501(c)(3).
(C) Administration. The transferred assets are administered in an identifiable or separate fund, some or all of the principal of which is not to be distributed for a specified period, if the public charity (including a participating trustee, custodian, or agent in the case of a community trust) is the legal and equitable owner of the fund and the governing body exercises ultimate and direct authority and control over such fund, as, for example, a fund to endow a chair at a university or a medical research fund at a hospital. In the case of a community trust, the transferred assets must be administered in or as a component part of the community trust within the meaning of §1.170A-9(e)(11).
(D) Restrictions on disposition. The transferor private foundation transfers property the continued retention of which by the transferee is required by the transferor if such retention is important to the achievement of charitable or other similar purposes in the community because of the peculiar features of such property, as, for example, where a private foundation transfers a woodland preserve which is to be maintained by the public charity as an arboretum for the benefit of the community. Such a restriction does not include a restriction on the disposition of an investment asset or the distribution of income.13
Factors that are considered as adverse in making this determination are listed as:
(1) With respect to distributions made after April 19, 1977, the transferor private foundation, a disqualified person with respect thereto, or any person or committee designated by, or pursuant to the terms of an agreement with, such a person (hereinafter referred to as "donor"), reserves the right, directly or indirectly, to name (other than by designation in the instrument of transfer of particular section 509(a)(1), (2), or (3) organizations) the persons to which the transferee public charity must distribute, or to direct the timing of such distributions (other than by direction in the instrument of transfer that some or all of the principal, as opposed to specific assets, not be distributed for a specified period) as, for example, by a power of appointment. The Internal Revenue Service will examine carefully whether the seeking of advice by the transferee from, or the giving of advice by, any donor after the assets have been transferred to the transferee constitutes an indirect reservation of a right to direct such distributions. In any such case, the reservation of such a right will be considered to exist where the only criterion considered by the public charity in making a distribution of income or principal from a donor's fund is advice offered by the donor. Whether there is a reservation of such a right will be determined from all of the facts and circumstances, including, but not limited to, the facts contained in paragraph (a)(8)(iv)(A)(2) and (3) of this section.
(2) The presence of some or all of the following factors will indicate that the reservation of such a right does not exist:
(i) There has been an independent investigation by the staff of the public charity evaluating whether the donor's advice is consistent with specific charitable needs most deserving of support by the public charity (as determined by the public charity);
(ii) The public charity has promulgated guidelines enumerating specific charitable needs consistent with the charitable purposes of the public charity and the donor's advice is consistent with such guidelines;
(iii) The public charity has instituted an educational program publicizing to donors and other persons the guidelines enumerating specific charitable needs consistent with the charitable purposes of the public charity;
(iv) The public charity distributes funds in excess of amounts distributed from the donor's fund to the same or similar types of organizations or charitable needs as those recommended by the donor; and
(v) The public charity's solicitations (written or oral) for funds specifically state that such public charity will not be bound by advice offered by the donor.
(3) The presence of some or all of the following factors will indicate the reservation of such a right does exist:
(i) The solicitations (written or oral) of funds by the public charity state or imply, or a pattern of conduct on the part of the public charity creates an expectation, that the donor's advice will be followed;
(ii) The advice of a donor (whether or not restricted to a distribution of income or principal from the donor's trust or fund) is limited to distributions of amounts from the donor's fund, and the factors described in paragraph (a)(8)(iv)(A)(2 )(i) or (ii) of this section are not present;
(iii) Only the advice of the donor as to distributions of such donor's fund is solicited by the public charity and no procedure is provided for considering advice from persons other than the donor with respect to such fund; and
(iv) For the taxable year and all prior taxable years the public charity follows the advice of all donors with respect to their funds substantially all of the time.
(B) Other action or withholding of action. The terms of the transfer agreement, or any expressed or implied understanding, require the public charity to take or withhold action with respect to the transferred assets which is not designed to further one or more of the exempt purposes of the public charity, and such action or withholding of action would, if performed by the transferor private foundation with respect to such assets, have subjected the transferor to tax under chapter 42 (other than with respect to the minimum investment return requirement of section 4942(e)).
(C) Assumption of leases, etc. The public charity assumes leases, contractual obligations, or liabilities of the transferor private foundation, or takes the assets thereof subject to such liabilities (including obligations under commitments or pledges to donees of the transferor private foundation), for purposes inconsistent with the purposes or best interests of the public charity, other than the payment of the transferor's chapter 42 taxes incurred prior to the transfer to the public charity to the extent of the value of the assets transferred.
(D) Retention of investment assets. The transferee public charity is required by any restriction or agreement (other than a restriction or agreement imposed or required by law or regulatory authority), express or implied, to retain any securities or other investment assets transferred to it by the private foundation. In a case where such transferred assets consistently produce a low annual return of income, the Internal Revenue Service will examine carefully whether the transferee is required by any such restriction or agreement to retain such assets.
(E) Right of first refusal. An agreement is entered into in connection with the transfer of securities or other property which grants directly or indirectly to the transferor private foundation or any disqualified person with respect thereto a right of first refusal with respect to the transferred securities or other property when and if disposed of by the public charity, unless such securities or other property was acquired by the transferor private foundation subject to such right of first refusal prior to October 9, 1969.
(F) Relationships. An agreement is entered into between the transferor private foundation and the transferee public charity which establishes irrevocable relationships with respect to the maintenance or management of assets transferred to the public charity, such as continuing relationships with banks, brokerage firms, investment counselors, or other advisors with regard to the investments or other property transferred to the public charity (other than a relationship with a trustee, custodian, or agent for a community trust acting as such). The transfer of property to a public charity subject to contractual obligations which were established prior to November 11, 1976 between the transferor private foundation and persons other than disqualified persons with respect to such foundation will not be treated as prohibited under the preceding sentence, but only if such contractual obligations were not entered into pursuant to a plan to terminate the private foundation status of the transferor under section 507(b)(1)(A) and if the continuation of such contractual obligations is in the best interests of the public charity.
(G) Other conditions. Any other condition is imposed on action by the public charity which prevents it from exercising ultimate control over the assets received from the transferor private foundation for purposes consistent with its exempt purposes.14
Although donor advised funds originated with these component funds of community trusts, they are now used widely by many other types of public charities, including those with a national base of support. As noted above, this has led to confusion over exactly what rules apply to donor advised funds.15
Private Letter Rulings
Most of the private letter rulings referring to donor advised funds involve component funds of community foundation-type charities. A review of some of these rulings may be illustrative of how these funds work and the types of issues that arise with them.
In Ltr. Rul. 8836033, the Service approved a transfer of all of the assets of a private foundation to a donor advised fund of a community foundation. The private foundation would continue in existence as such for the sole purpose of advising the community foundation on the use of the donor advised fund that is to be established. The charitable purposes of the community foundation were similar to the charitable purposes of the private foundation.
In Ltr. Rul. 8936002, the IRS ruled that the administration of donor advised funds by a Code Section 170(b)(1)(A)(vi) charity was related to the charity's exempt purpose and would not jeopardize its Code Section 501(c)(3) status. In addition, the Service held that the fees the charity received for administering the donor advised funds would not be unrelated business taxable income. The fees and interest income received by the charity may have exceeded its cost in administering the funds. The charity solicited the funds for activities that the charity wished to fund in furtherance of accomplishing its own exempt purposes. The Service commented that the final decision as to the distribution of the funds rested with the charity and no distributions were made which the charity did not approve of and agree to, even though the donors retained some direction over and involvement with the distributions. The Service noted that there was no evidence that any person received a personal or private benefit through "abusive commissions, non-charitable projects or insider payments to donors.
A trustee of a private foundation proposed to establish a donor advised fund as a separate fund within the private foundation in Ltr. Rul. 9412039. The fund would hold contributions from the trustee until the death of the survivor of the trustee and the trustee's spouse, who was also a trustee of the private foundation. At the death of the survivor, the assets in the fund would revert back to the private foundation. The IRS ruled that the fund would not affect the private foundation's exempt status under Code Section 501(c)(3). The IRS observed that there would be no material conditions or restrictions on the assets transferred by the trustee to the fund. An advisory committee would make recommendations on distributions from the fund but the private foundation's board would have the power to disregard those recommendations. In addition, the trustee making the contributions was only one of three trustees so the board would have the ability to act independently from the trustee. The Service also ruled that the fund would be treated as an integral part of the foundation and not as a separate entity.
In Ltr. Rul. 9532027, the IRS issued favorable rulings on the ability of two sons to disclaim property where the property would pass into donor advised funds over which the respective son would have the power to make recommendations to a charity regarding grants to other charities. In reaching its decision, the Service noted that neither charity would be bound by the respective son's recommendations.
The Service approved a private foundation's transfer of 10% of its assets to a donor advised fund of a community trust in Ltr. Rul. 9807030. Specifically, the Service ruled that the donor advised funds would not be treated as separate trusts classified as private foundations and there were no material restrictions or conditions on their assets within the meaning of Treasury Regulation Section 1.170A-9(e)(11). The board of the community trust would have the power to direct distributions of the donor advised funds despite recommendations suggested by the private foundation's board if the community trust's board believes "such action is necessary to most effectively accomplish the general purposes" of the community trust.
In Ltr. Rul. 200009048, the Service again gave favorable rulings on a private foundation's transfer of all of its assets to a donor advised fund of a public charity described in Code Section 170(b)(1)(A)(vi). The private foundation planned to dissolve after the transfer and its current trustees would serve as an advisory committee for purposes of making non-binding recommendations on the amounts and recipients of distributions from the donor advised fund. The public charity would make an independent determination as to whether any such advice is consistent with its exempt purposes. In reaching its favorable decision, the Service noted that there would be no material restrictions or conditions on the public charity's use of the donor advised fund assets.
In the oldest private letter ruling on topic(Ltr. Rul. 8134046), a charity terminating private foundation status adopted a program to establish and operate donor advised funds as component funds of the charity under Treasury Regulation Section 1.170A-9(e)(11)(ii). The "new" charity had also applied for and received exempt status for a pooled common fund under Code Section 170(b)(1)(E)(iii).16 The donor directed fund was established as a trust and was classified as a private foundation. Two donors made contributions to the organization to be held in the donor advised funds. The two donors then requested that the funds in the donor advised funds be transferred to the pooled common funds. As a reason for the request, the charity indicated in part that it wanted to eliminate any risk of loss of its public charity status under Code Section 509(a)(1) because of a failure to operate the advised funds as component funds under the Regulations.
Among other things, the Internal Revenue Service ("IRS" or "Service") ruled that the donor advised funds would not be treated as component funds from their inception because implementation of the transaction described would result in a material restriction under Treasury Regulation Section 1.507-2(a)(8). The restriction arose because the donors would now be seeking to transfer those assets to a pooled common fund under Code Section 170(b)(1)(E)(iii). Therefore, the Service found that the donor advised funds would "be treated as held in trust separate and apart from the community trust from inception." The Service noted that the private foundation excise tax provisions would also apply to these funds from their inception.17
In reviewing the cases, one basic issue that arises is whether the entities described are actually donor advised funds. None of the court opinions specifically refer to the charities or the funds they administer as donor advised funds.
National Foundation, Inc.
In National Foundation, Inc. v. United States, the United States Claims Court ruled that the National Foundation, Inc., a nonprofit corporation, was exempt from tax under Code Section 501(c)(3) because it was organized and operated for exempt purposes and no part of its earnings inured to the benefit of private individuals. According to the Court, National Foundation, Inc.'s exemption application stated that its purposes were to raise and distribute funds to other nonprofits and to initiate, fund and administer a variety of charitable projects.
An interested person could establish a charitable project or an account by submitting an application to National Foundation, Inc., along with a nonrefundable $100 application fee and a minimum initial contribution of $500. The $500, net of fundraising and administrative costs of 8 and 1/2%, would be donated to the project if the project was approved by National Foundation, Inc.'s executive director and then by its Board of Directors. The Board had the sole discretion to approve or disapprove a project. The factors National Foundation, Inc. would consider in evaluating a project or disbursement request were listed as:
(1) the project must clearly be of a type described in section 501(c)(3) of the Internal Revenue Code; (2) the project or disbursement must serve a public purpose and must not result in private gain or inurement to any individual; (3) each project application or request for disbursement must be supported by adequate documentation; (4) the scope of the project must be adequately described on a statement of proposed financial activity; (5) if the requested donee is an organization, there must be proof that the organization is a qualified tax-exempt entity; and (6) the board must determine that it can effectively administer the project given its proposed scope, level of activities, geographic location, and other factors.18
The Court noted that, if a proposal were rejected, the donor could receive his or her $500 back, allow the $500 to be donated to a qualified charity, or allow the $500 to be retained by National Foundation, Inc. While a donor's proposal was under consideration, the $500 would be treated as an escrow or custodial fund.
Once a donor committed his funds for use in a project or for general use by National Foundation, Inc., the funds would be under National Foundation, Inc.'s "full control, ownership and discretion." National Foundation, Inc. would not be required to use the funds as requested by the donor. After that time, if the donor became unhappy with how his or her funds were being used, the donor would not have legal recourse but could request that the funds be distributed to another Code Section 501(c)(3) entity. The Court noted that National Foundation, Inc.'s policy was that a donor's proposal would be honored if it was consistent with the stated purposes of the project, IRS requirements and National Foundation, Inc.'s policies.
The Court indicated that "charitable development officers" would find donors for National Foundation, Inc., and these charitable development officers would receive a commission of $50 out of every $100 application fee. The charitable development officers were typically lawyers, accountants, stockbrokers, trust officers, insurance underwriters, ministers, and officers of other charities.
Each project was treated as a distinct charitable project so National Foundation, Inc. maintained segregated internal accounting of the project's financial activities. The Court noted that the sub-accounts were not separate funds or separate legal entities. According to the Court, the only entity was National Foundation, Inc. and it maintained "only a single fund in which all of its assets are combined and invested and from which expenditures are made." The Court observed that National Foundation, Inc. gave its donors "the privilege of earmarking a contribution for a particular project or charitable use."
In finding that National Foundation, Inc. was a valid Code Section 501(c)(3) entity, the Court rejected the Service's arguments that National Foundation, Inc. accomplished no charitable goals but only allowed its "foundation clients" to escape IRS scrutiny and private foundation classification, that it merely served as a conduit for its donors where the donors maintained control over their donations, that it was nothing more than an aggregate of separate organizations and that it was involved in too many charitable projects. The Court stated that National Foundation, Inc.'s "methods of operation may be somewhat unique and innovative, but by its approach, [National Foundation, Inc.] offers another way to harness both the sensitivity to local community needs and the charitable creativity of public-minded citizens throughout the country."
Among other things, the Court also found that the commissions paid by National Foundation, Inc. were reasonable and that it should not be treated as a private foundation. The Court rejected the Service's argument for private foundation status because it found that at least a third of National Foundation, Inc.'s support was coming from the general public and not more than a third was coming from investment income in accordance with Code Section 509(a)(1).19
The Fund for Anonymous Gifts
In The Fund for Anonymous Gifts v. I.R.S., the United States Court of Appeals for the District of Columbia Circuit in an unpublished opinion vacated and remanded a District Court's decision regarding the status of a charitable organization. The Court of Appeals found that the Fund was a Code Section 501(c)(3) charitable organization but remanded on the issue of whether the Fund was a public charity or a private foundation.
As described by the District Court, the Fund was created by an agreement naming an individual as trustee.20 Under the agreement, the Fund's charitable purposes were to be carried out by gifts to public charities. Donors would be allowed to make gifts on an anonymous basis while still obtaining a charitable deduction. The District Court observed that the fund also had a second unstated purpose of providing investment services to donors because the donors were allowed to direct how their gifts would be invested and the distribution of income from those gifts to other charities at a later date.
In addition to arguing that the Fund was not a Code Section 501(c)(3) entity, the IRS also argued that the Fund was structured so as to circumvent the private foundation rules. Because the District Court agreed that the Fund was not a Code Section 501(c)(3) entity, it did not reach the issue of whether the Fund was a public charity or private foundation. The District Court distinguished the Fund from Fidelity Investments' Charitable Gift Fund because Fidelity merely allowed donors to allocate donations among three investment pools with no continuing control over investments while the Fund's trustee would be bound by the investment decisions of its donors. Further, Fidelity's circular contained very detailed rules about the operations of its charity and suggested that its donors needed to consult their own advisors about available charitable deductions.21
Before appealing the decision of the District Court, the Fund agreed to retroactively modify the agreement governing its operations so as to eliminate provisions allowing donors to place conditions subsequent on their gifts. The Fund appealed the District Court's decision to the Court of Appeals when it found that it was still unable to reach an agreement with the IRS. As indicated above, the Court of Appeals ruled that the Fund was a Code Section 501(c)(3) entity, noting that it was "baffled by the government's apparent intransigence." The Court of Appeals ordered the District Court to enter summary judgment holding that the Fund was a Code Section 501(c)(3) entity and to determine on remand if the Fund was a publicly supported charity or not.22
New Dynamics Foundation Case
Apparently in a similar vein, the case of New Dynamics Foundation v. United States is currently pending before the United States Claims Court. The Service denied the entity's application for tax-exempt status.23 According to the Service, the Foundation was allowing donors to form individual "donor advised foundations" under its guidance and control. The donors were able to make recommendations as to how their gifts should be invested and distributed. The Foundation's board would consider the donors' recommendations but the board would always have control of the ultimate decisions on investments. The Service suggests that this case could have ramifications affecting "the future development of donor advised fund issues."24
IRS Continuing Professional Education
In its 2000 Continuing Professional Education for Exempt Organizations, the Service lists as a topic under public charity classification and private foundation issues, "'Aggressive' interpretations of provisions applicable to donor advised or directed funds and IRC 509(a)(3) supporting organizations."25 In its discussion of donor advised funds,26 the Service states that it has approved exempt status for certain donor advised fund organizations in the past year. It states that these applications had all included representations subjecting them to the conditions imposed on private foundations under Code Sections 494227 and 4945,28 which were very important to the Service in giving its blessings to them. Specifically, the Service lists:
i. The organization expects that its grant distributions for the year will equal or exceed five percent of its average net assets on a fiscal year rolling basis. If this level of grant activity is not attained, the organization will identify the named accounts from which grants over the same period totaled less than five percent of each account's average assets. The organization will then contact the donor-advisors of these accounts to request that they recommend grants of at least this amount. If a donor-advisor does not provide the qualified grant recommendations, the organization is authorized to transfer up to five percent of assets from the donor-advisor's named account to the charity selected by the organization.
ii. The organization will add language to its promotional materials which indicates that the organization will investigate allegations of improper use of grant funds for the private benefit of donor-advisors.
iii. The organization will add language to its grantee letters to the effect that grants are to be used by grantees exclusively in furtherance of charitable purposes, and cannot be used for the private benefit of donor-advisors.29
The Service states that a donor advised fund must have appropriate controls over donated assets in order to be exempt under Code Section 501(c)(3), citing The Fund for Anonymous Gifts and National Foundation, Inc. cases discussed above. It goes on to state that it applies the material restriction provisions of Treasury Regulation Section 1.507-2(a)(8) to measure the amount of control.30
However, IRS Director of Exempt Organizations, Marcus Owens, has indicated that there is a distinction between donor advised funds and donor directed funds.31 He referenced the New Dynamics Foundation v. United States case and indicated that donor advised funds "do not raise the same concerns" as donor directed funds.32
Use of Donor Advised Funds
As noted above, donor advised funds have traditionally been used mainly by community foundations. Because donors liked the advantages of an immediate charitable deduction, favorable percentage limitations for contributions, name recognition, the ability to make recommendations for distributions, and ease of use, donor advised funds eventually expanded to universities and other charities, including charities with a national scope. Another appeal is that donors are sometimes given the opportunity to specify how the donor advised fund assets will be invested prior to distribution. Donor advised funds are touted as a less costly and less complex alternative to supporting organizations and private foundations, but with many of the same benefits.
In more recent years, several for-profit financial institutions have established public charities allowing donors to make gifts with donor advised funds. Fidelity Investments' Charitable Gift Fund, which was established in 1992, has become the largest of these having made grants in excess of $1 billion since its inception. Some people have raised concerns about the growth of donor advised funds created by financial institutions. They are concerned that these entities are shifting donor support away from "traditional" public charities, like community foundations. Some have noted that these newer entities may be motivated more by the financial institutions' desire to increase the assets under their management and that there may be little or no review of the grants made. Concern has also been raised as to whether sufficient distributions are being made for charitable purposes. On the other hand, others have applauded these new donor advised funds as making charitable giving more popular, convenient, and more available to donors who might not have otherwise considered lifetime gifts.
The use and popularity of donor advised funds has grown significantly in recent years. Donor advised funds have many advantages including ease of use, immediate charitable deductions, favorable percentage limitations, donor recognition and donor involvement via non-binding advice. However, the increased use of donor advised funds outside of the traditional community foundation or other public charity arena, along with the large growth in the amount of assets held in donor advised funds as a result of the new charities set up in connection with for-profit financial institutions, has led to increased concern about potential abuses.
As a result, the President's fiscal year 2001 budget proposal contains a proposal for new laws governing donor advised funds. This proposal attempts to define a "donor advised fund," apply private foundation rules to these funds, and reclassify the public charity as a private foundation under certain circumstances. It is not clear whether such legislation would increase the use of donor advised funds or would have a chilling effect on their use. A comprehensive analysis of this legislation will be undertaken in Part II of this two-part article.
All references to the Code are to the Internal Revenue Code of 1986, as amended from time to time.back
See Joint Committee on Taxation's Description of Revenue Provisions Contained in the President's Fiscal Year 2001 Budget Proposal.back
See, e.g., Ltr. Rul. 8134046 (May 26, 1981); Ltr. Rul. 8836033 (June 14, 1988); Ltr. Rul. 8936002 (May 24, 1989); Ltr. Rul. 9412039 (Dec. 23, 1993); Ltr. Rul. 9532027 (May 12, 1995); Ltr. Rul. 9807030 (Nov. 19, 1997); Ltr. Rul. 200009048 (Nov. 24, 1999); and Ltr. Rul. 200010036 (Dec. 13, 1999).back
Code Section 6019 provides in part that a transfer by gift need not be reported on a gift tax return if the transfer is one "with respect to which a deduction is allowed under section 2522" but only if "such transfer is of the donor's entire interest in the property transferred" and "no other interest in such property is or has been transferred (for less than adequate and full consideration in money or money's worth) from the donor to a person, or for a use, not described in subsection (a) or (b) of section 2522" or the transfer is described in Code Section 2522(d).back
See also Treas. Reg. § 1.170A-9(h), which sets forth other requirements, including distribution requirements, for an entity described in Code Section 170(b)(1)(E)(iii).back
See Reg. §1.170A-9(e)(10).back
See Joint Committee on Taxation's Description of Revenue Provisions Contained in the President's Fiscal Year 2001 Budget Proposal.back
The ruling cites former Code Section 170(b)(1)(D)(iii).back
National Foundation, Inc. lost a subsequent request for attorney's fees under the Equal Access to Justice Act in 1988.back
97-2 USTC 50,710 (April 15, 1997).back
99-1 USTC 50,440 (April 12, 1999).back
The IRS notes that this discussion is an update of the discussions in its 1996 Continuing Professional Education text on "donor directed funds" and in its 1999 Continuing Professional Education text on gift funds.back
This Code Section imposes an excise tax on private foundations that fail to make sufficient distributions.back
Code Section 4945 imposes an excise tax on private foundations that has certain "jeopardizing" investments.back