The past several years have witnessed a spike in interest in donor-advised funds (DAFs) among investors. Contributions to DAFs rose 80% between 2015 and 2019 as grants made from money in DAFs skyrocketed by 93%.
Yet, DAFs still face hurdles even against this striking progress, particularly related to how money actually reaches the intended targets. Now, new and controversial legislation aims to speed up the distribution of these funds. The legislation’s proposed changes highlight some of the fundamental elements that differentiate these funds from others.
What Are Donor-Advised Funds?
DAFs are a type of philanthropic investment account to which donors can contribute cash and other assets. The DAF then directs these contributions to IRS-qualified charities. Donors generally receive an immediate charitable tax deduction—a maximum of 60% of their adjusted gross income when they donate cash and 30% for appreciated stock. That marks a significantly higher deduction than is allowed for such contributions to a private foundation. Furthermore, the money then grows tax-free as the donors recommend grants to the charities of their choice. DAFs are irrevocable, so donors cannot dip into the money for their own use.
In the 1990s, a donor-advised fund formed by a charity affiliated with Fidelity Investments spurred DAFs to popularity. The more recent rush to embrace DAFs kicked off in the wake of the 2017 tax law stipulating that households claiming the new, higher standard deduction could not reduce their taxable income through charitable contributions. However, in what are known as “bunched” contributions, donor-advised funds allow taxpayers to make multiple years’ worth of charitable gifts to a DAF in just one year and surpass the standard deduction. They can then claim the charitable deduction for that bunched amount, distributing specific grants to charities at their leisure and on their own schedule.
The legislation also includes changes to regulations that affect private foundations.
New DAF Legislation Addresses Flow of Capital
This approach to distributing funds has inspired the new legislation. Unlike private foundations, which must distribute 5% of their endowments per year to retain their tax status, DAF donors receive full tax benefits for their donations immediately. This remains true even if they never give away any of the money. In fact, more than $140 billion in funds is currently sitting in DAFs waiting to be distributed.
With that in mind, senators Angus King (I-ME) and Chuck Grassley (R-IA) introduced legislation in June 2021 requiring donor-advised funds to donate a minimum amount to charity according to a certain timetable. Called the Accelerating Charitable Efforts (ACE) Act, the bill would require DAFs to make donated funds available to charities in a “reasonable” period of time.
Specifically, it establishes two categories of DAFs:
- With one, donors would receive up-front tax benefits only if funds are distributed within 15 years of the donation.
- The other offers up to 50 years to make contributions but defer deductions until that distribution was made. However, donors would get immediate capital gains and estate tax benefits upon donation.
The legislation also includes changes to regulations that affect private foundations. For example, the bill states that such organizations would no longer be allowed to meet their annual distribution requirements by giving to DAFs that have no mandated payout time frame or by including the salaries or travel expenses of donors’ family members. At the same time, it would allow donors to keep up to $1 million in community foundations without having to meet the new payout regulations.
Reaction to the bill has been mixed. Although backers include coalitions of such heavy-hitters as the Ford Foundation and W.K. Kellogg Foundation, some philanthropy advocates actively oppose it. The Community Foundation Public Awareness Initiative, Council on Foundations, Independent Sector, Philanthropy Roundtable, and United Philanthropy Forum criticized the legislation with a letter to Congress arguing the legislation would hurt DAFs’ status as “a lifeline for charities during the pandemic,” as well as challenging the idea that the changes would inspire an increase in charitable giving. The Council on Foundations stated the new requirements “would negatively impact the philanthropic sector.” Council on Foundations CEO Kathleen Enright said in a Chronicle of Philanthropy interview that if the bill were to advance in the Senate, “We expect a big, pitched battled over it.”
Foundations Seek to Speed Funding
Efforts are also underway to ramp up the amount of foundation funding that can be raised and quickly distributed. These include plans for foundations to issue 30-and-50-year bonds—an unusual move that would allow nonprofits to boost their financing abilities. Last summer, a group of about 200 wealthy individuals also called on Congress to double the required foundation payout for the next three years.
For those aiming to boost their impact through DAFs, these developments will help define the shape of future investments.