DAF Proposed Regulations: Overview and Comment Summary, Part I

Next month, a panel sponsored by TEGE Exempt Organizations Council and the DC Bar Association will talk about DAFs as part of a two-day exempt orgs update.  Our task is to lead a discussion of the proposed DAF regulations on Taxable Distributions and the comments submitted in response to the NPRM.  Some people have already published some good stuff on the topic, but if you want a comprehensive sort of start to finish policy discussion meet us in DC on March 7 – 8, 2024.  I gotta read the regs carefully for the first time this week, along with about 135 comments.  I hope to divide comments into subject matter categories, identify consensus or disagreement, and along the way make some editorial observations and comments.  They always have free coffee and donuts at these things so I intend to earn my keep ya know. Can’t just show up pontificating if there is free coffee and donuts.  I’ve started by isolating the topical requests for comments in the NPRM.  This week, I will report on and respond to comments as I read them.  Here are Treasury’s specific comment requests and some preliminary thoughts.  Feel free to correct or educate me:

1. The Treasury Department and the IRS request comments on the circumstances in which a gift agreement or advisory rights retained by a donor could create a DAF.

To be a donor advised fund, subject to 4958, 4966, and 4967, a donor or donor designated advisor (donor-advisor) must have or reasonably expect to have advisory privileges regarding the fund.  Prop. Treas. Reg. 53.4966-1(g); Prop. Treas. Reg.  53.4966-3(a)(3). Treasury wants to know whether conditions placed on the gift at the time the gift is made constitute advisory privileges. 

2. The Treasury Department and the IRS request comments on additional circumstances that would indicate that a personal investment advisor is properly viewed as providing services to the sponsoring organization as a whole, rather than providing services to the DAF, as well as additional circumstances in which a personal investment advisor should not be considered a donor-advisor.

An investment advisor that provides personal investment advice to a donor will be a donor-advisor with advisory privileges if the investment advisor also advises the sponsoring organizations regarding investments from the donor’s DAF.  Even if the donor does not explicitly designate or recommend the investment advisor to the DAF as having advisory privileges.  Prop. Treas. 53.4966-1(h)(3).  But if the investment advisor provides overarching advice to the sponsoring organization regarding all of its DAF’s, the investment advisor will not be deemed a donor-advisor.  Apparently, the duty to advise regarding all of the DAFs provides a check on the investment advisor’s apparent conflict of interest.  Treasury wants to know whether there are other circumstances that justify not automatically treating a donor’s personal investment advisor as a donor-advisor. 

3. Treasury Department and the IRS request comments on what constitutes a significant contributor for purposes of this exception.

To be a DAF, a donor or donor-advisor must have advisory privileges.  Does a donor or donor-advisor’s service on a whole committee that advises a DAF have advisory privileges with regard to the DAF?  The proposed regulations say “only if the donor is a substantial contributor.”  (There are other reasons why service on an advisory committee would constitute deemed advisory privileges.)  Prop. Treas. Reg. 53.4966-3(c)(1)(iii)(C).  The statute does not define “substantial contributor” but 4958(c)(3)(C) does.

4. The Treasury Department and the IRS request comments on whether and in what circumstances additional types of exceptions are warranted to allow multiple-donor funds or accounts to be excluded from the definition of DAF. The Treasury Department and the IRS are particularly interested in comments addressing how any exception for multiple-donor funds or accounts can be crafted to prevent circumvention of the provisions of section 4966 while still being administrable for both sponsoring organizations and the IRS.

Stakeholders in response to previous requests for comments suggested that funds to which multiple donors contribute should be excluded from the definition of a DAF.  Apparently, the multiplicity of donors suggests that no single donor would have enough influence to cause any abuse.  Stakeholders are concerned that including multiple donor funds would discourage “giving circles” or “giving pools” to which multiple donors contribute – via an alumni or professional association, according to the preamble.  Treasury thinks the advisory committee exception provides enough flexibility that one or more donors can engage the fund without it being considered a DAF.  Prop. Treas. Reg. 53.4966-3(c)(1)(iii)(C).  It also thinks that since most giving circles and pools will be sponsored by a governmental unit or public charity, both of which are exempt from the definition of “donor,” the governmental unit or public charity could advise the giving pool/circle DAF without subjecting the DAF to the proposed regulations.  This, because government units and public charities are not “donors” the advice of which would be covered by the regulations.  Prop. Treas. Reg. 53.4966-1(f).

5. The Treasury Department and the IRS request comments on the proposed advisory committee exceptions, including additional circumstances in which advisory privileges arising from advisory committees should not result in the creation of a DAF.    See number 4 above.  
6. The Treasury Department and the IRS request comments on whether other funds should be excepted from the definition of DAF using the authority under section 4966(d)(2)(C) and what, if any, restrictions should apply to ensure that the intent of section 4966 is achieved. 

Scholarship and disaster relief funds are specifically excepted from the definition of a DAF.  In addition, a fund that distributes only to a single charitable “purpose” with regard to which a donor does not retain discretion to alter recipients are excluded.  Proposed Treas. Reg. 53.4966-4(a).  Incidentally, the preamble uses the word “purpose” but the statute and proposed regulation states that distributions must be made to a single “organization.” The preamble language suggests that multiple organizations can receive distributions if they share a common purpose.  Probably the word “purpose” should be eliminated in the preamble, just to be sure.  Anyway, additional suggested exceptions need to satisfy an overriding criteria:  no donor discretion to directly or indirectly alter distributions

7. The Treasury Department and the IRS request comments on whether additional guidance is needed on situations in which a fund or account is established at a public charity and the written agreement establishing the fund or account provides that the contributed amounts can only be used to support programs within that public charity, but the donor retains advisory privileges with respect to the public charity’s use or investment of some or all of the funds.

If a DAF can make distributions to only a single organization, the donor does not have the sort of advisory privileges that can be used for private benefit.  But if the donor also controls how the single organization uses the grants from the DAF, the donor effectively has advisory privileges over the use of the DAF’s distributions.  Prop. Treas. Reg. 53.4966-4(a)(4).  Hence, the donor should be covered by the proposed regulations.  A sort of look-thru rule.

8. The Treasury Department and the IRS request comments on whether additional guidance is needed to prevent avoidance of the employer-related scholarship rules or to address any potential private benefit arising from employer-related scholarship programs.

I used to know all about 117, but I don’t quite understand the concern here except that the exclusion of scholarships DAFs in Proposed Treas. Reg. 53.4966-4(b) could allow a donor to make scholarship grants to his or her own kids.  I’m not sure Treasury can do much about the possibility in these proposed regulations.  If the DAFs are not covered by 4966, adopt the 117 regs that have been sitting around in proposed form for decades or address the problem in 4945.  Anyway, here is the concern is articulated in the preamble:

The Treasury Department and the IRS are concerned that some employers may seek to use this statutory scholarship exception to grant employer-related scholarships in a manner that would otherwise not be considered a scholarship or fellowship grant subject to the provisions of section 117(a), or that would otherwise be a taxable expenditure under section 4945, by having a sponsoring organization administer their scholarship programs. See, e.g., Rev. Proc. 76–47, 1976–2 C.B. 670, and Rev. Proc. 80–39, 1980–2 C.B. 772.

9. Given this concern, the Treasury Department and the IRS request comments on how to identify a broad-based membership organization described in section 501(c)(4), including factors such as the organization’s number of members, criteria for selecting members, membership rights, and geographic coverage.

Social welfare organizations are not excluded from the definition of “donor.”   So if a (c)(4) donor serves on a scholarship committee administering a scholarship DAF, for example, the (c)(4) would most likely have advisory privileges making the DAF subject to 4966 even though it is similar to the statutorily excepted scholarship DAFs.  Under a “Rotary Club” exception, a (c)(4) could be exempted from the definition of “donor” thereby exempting the DAF from 4966.  53.4966-4(c).   The Treasury wants to insure the (c)(4) will have no ability to control the DAF to benefit the (c)(4)’s members.

10. The Treasury Department and the IRS also request comments on whether and under what circumstances other organizations, such as section 501(c)(5) and 501(c)(6) organizations, use similar types of committee-advised scholarship funds and whether the exception should be extended to those organizations, recognizing that section 501(c)(4) organizations are formed to promote social welfare whereas section 501(c)(5) (labor, agricultural, and horticultural organizations) and section 501(c)(6) (business leagues) organizations are formed to further different purposes.

One supposes that rules allowing (c)(4) organizations to serve as donors and give advice without being treated as donors giving advice could be extended to (c)(5) and (6) organizations.  Of course, the more exceptions in the regulations, the more opportunity for abuse.  The Service probably needs some analytics on this before extending the exception.

11. The Treasury Department and the IRS request comments on how to further distinguish distributions from investments.

IRC 4966 applies to “distributions,” which the regulations define broadly but which excludes “investments.”  Treasury is looking for better rules to ferret out distributions disguised as “investments.”  For example a zero or low interest loan to a donor might actually be akin to the free use of money, and hence private benefit.  Proposed Treas. Reg. 53.4966-1(e).  The proposed regs would label the low or no interest loan a “deemed distribution.”

12. The Treasury Department and the IRS request comments on whether other entities should be included in the definition of disqualified supporting organization, using the authority under section 4966(d)(4)(A)(ii)(II) to designate other supporting organizations as disqualified, because a distribution to such organization is inappropriate if expenditure responsibility is not exercised to ensure the distribution is for a purpose specified in section 170(c)(2)(B).

Apparently, you really don’t want to be a “disqualified supporting organization,” under IRC 4966.  I gotta go read up on that a little bit more.  I’ll reserve editorial comment.

13. The Treasury Department and the IRS request comments on this modification to the expenditure responsibility rules and whether additional guidance is needed.

A taxable expenditure is any distribution to a natural person, or any distribution not to a governmental unit or public charity without expenditure responsibility.  53.4966-5(a)(1)(ii)(B).  With a few modifications – e.g., the distributee must agree to exercise expenditure authority over distributions it makes from distributions received from the DAF — it sounds like the normal expenditure responsibility procedures will be sufficient. 

14. The Treasury Department and the IRS request comments on whether guidance is needed regarding a fund manager’s reliance on professional advice.

Fund managers are liable for a 5% excise tax for approving a taxable distribution if they know or should have known the distribution was bad.  Naturally, the “should have known” basis ought to be eliminated if the fund manager relied on professional advice.  The regulations don’t explicitly propose language in that regard. 

darryll k. jones