Understanding the IRS Hearing on Proposed Changes to Donor Advised Funds
A post from Aimee Minnich, Impact Foundation’s Co-founder and CIO
In early May, I traveled to Washington, D.C., to testify at an IRS hearing about recently proposed rules for donor advised funds. These rules have the potential to limit the generosity fueling transformation in our country and around the world. Impact Foundation and many other organizations have been following the situation closely and showed up to testify. Here’s a summary of the proposed rules and the concerns, plus a call to prayer.
Background on Donor Advised Funds
Donor advised funds were created in the 1930s, but in 2006 Congress enacted the Pension Protection Act (PPA), which included the first laws specifically addressing donor advised funds. The law added to the tax code a definition of a donor advised fund (DAF) and created new rules for DAF sponsors to follow. The PPA also directed the Treasury and IRS to create regulations clarifying certain points in the law.
The industry has been waiting and expecting rules from Treasury/IRS. But in the meantime, DAF sponsors have figured out how to operate within the rules created by the PPA, and DAFs have increasingly become an important tool for strategic grant-makers who want to support positive change in their communities.
A few statistics on the size and growth of donor advised funds courtesy of the National Philanthropic Trust (link: https://www.nptrust.org/wp-content/uploads/2023/11/2023-DAF-Report.pdf)
DAF charitable assets amount to 20 percent of those in private foundations.
The value of DAF grants in 2022 amounts to 52.3 percent of the value of grants from private foundations.
In 2022, DAFs granted 22.5 percent of their assets from the previous year.
The Proposed Regulations
In late 2023, the Treasury/IRS issued proposed rules purporting to clarify IRC 4958 regarding excise taxes on impermissible distributions from a DAF, known as excess benefit transactions. You can read the full proposed regulations here. The consensus among people familiar with the industry is that the rules would have some unfortunate outcomes.
Objections to the Regulations
Commenters repeatedly told the Treasury/IRS about the great work being done through DAFs as they grant to charities and meet the needs of their local communities. Generosity is so much more than a tax loophole. It truly makes a difference.
In addition, commenters made the following points:
1. The Treasury/IRS doesn’t have the authority to enact these rules because they’re exceedingly overreaching.
2. The rules would significantly slow grant processing by foundations as they’d become responsible for how the underlying charity uses the funds.
3. The new rules expand the definition of DAF and make pooled interest funds and other arrangements subject to DAF rules that weren’t previously considered DAFs.
4. Investment advisors aren’t donor advisors and shouldn’t be treated as such. DAF sponsors should be allowed to pay investment advisors for services rendered.
My favorite quote of the day came from Emil Kallina, an attorney with Kallina & Associates in Maryland:
“Congress passed the PPA and its restrictions on DAF's based on anecdotal evidence, not on the study or analysis of how widespread the abuses actually were. They sought to curb a few bad actors in the charitable arena. Legislation based on anecdote usually does not produce the best result, but Congress has a right to do as it wishes. IRS and Treasury, on the other hand, have no such privilege to legislate policy upon anecdote.”
Mr. Kallina explained the case law supporting his conclusion that these proposed rules would be overturned because they go beyond the statutory authority of the law they purport to interpret.
Impact Foundation’s Main Objection
In addition to echoing the concerns of the other commenters, I raised another point. The thesis of my testimony:
"Because the definition of investment in the proposed regulations cannot be reconciled with the treatment of the concept in other laws, practitioners will be left wondering if the service intends to police our investments differently than we previously thought. But we do not have sufficient guidance to operate clearly within whatever the new scheme might be. Arrangements that would have been previously considered an investment seem to now be considered taxable distributions."
My full written comments are found here.
The Rulemaking Process - where do we go from here?
It’s unclear. There are multiple possibilities and no definitive timeline for resolution. Potential options include:
The IRS retracts the proposed rules and later issues a new proposal.
If the IRS adopts proposed rules as written, the industry will sue to have them struck down in whole or in part.
The IRS leaves the proposed rules on the books while it reworks them.
Invitation to Pray
Option 1, above, where the Treasury/IRS retracts the proposed regulations and reworks them, is the best. However, based on recent news in the last few weeks, it appears to be the least likely.
Please pray the Treasury/IRS and our leaders carefully listen to and consider the needs of the industry and those benefiting from the generosity of DAFs in adopting new regulations.