27 September 2022 - Article
In early December, the IRS issued Notice 2017-73 to give notice of possible regulations addressing three aspects raised by certain distributions by donor advised funds (DAF) and invited comments on certain transactions involving donor advised funds and private foundations. According to the notice, the IRS and Treasury Department are considering developing regulations to the effect that:
DAF distributions to purchase tickets
DAF distributions to purchase tickets enabling the DAF’s donor, advisor, or a related person to attend or participate in a charity-sponsored event result in more than an incidental benefit to such person. Section 4967 of the Code imposes a 125% excise tax on the DAF advisor or recipient if an advised distribution confers more than an incidental benefit on the DAF donor, DAF advisor, family member, or controlled entity with respect to such persons. These regulations clarify that the Section 4967 excise tax applies when the DAF purchases charity event tickets for use by the donor, advisor, or a related party.
These proposed regulations confirm what is widely viewed as the conservative practice on this issue.
Typically, charity event tickets issued to donors include a notice that some portion of the ticket price is attributed to the value of the event (such as food and entertainment), and only the remainder of such amount represents a charitable contribution. Some DAF donors have taken the position that, if the donor or related person pays the portion of the ticket price attributable to the stated value of attending and the DAF pays the charitable contribution element, there is no uncompensated benefit to the donor or related party. The Notice specifically addresses and rejects that argument. Others have argued that a ticket to attend the charity gala confers a burden not a benefit on the DAF donor or related party, who is expected to attend, bring colleagues, and donate to the charity conducting the event. Although the Notice does not address that argument, it is foreclosed by the proposed regulations.
DAF distributions satisfying enforceable or unenforceable charitable pledge
DAF distributions that are treated as satisfying an enforceable or unenforceable charitable pledge by the DAF donor, advisors, or related parties to contribute to the charity receiving the DAF distribution result in only an incidental benefit to the DAF donor, advisor, or related party. To qualify for this characterization, the DAF charity may make no reference to the existence of a charitable pledge when making the DAF distribution, the donor or advisor may receive no other direct or indirect benefit that is more than incidental on account of the DAF distribution, and the donor or advisor may not attempt to claim a charitable contribution deduction against income tax with respect to the DAF distribution.
The proposed regulations make clear that the Section 4967 excise tax does not apply to these pledge-satisfying distributions. Significantly, the Notice announces that taxpayers may rely on the rules described in this section of the Notice until additional guidance is issued, so this Notice provides a basis for reporting even before any regulations are issued.
The Notice confines its effect to Section 4967 and declines to extend a similar conclusion to grants by private foundations (or presumably to distributions by charitable reminder trusts or charitable lead trusts) that satisfy a donor’s pledge. In so doing, however, the Notice overlooks the 20% excise tax imposed on DAFs (and a 5% tax on DAF management) that make distributions to private individuals or to private foundations as to which expenditure responsibility is not exercised. This separate and distinct excise tax is implicated under the theory of Revenue Ruling 81-110, which concludes that a third party’s payment to a charitable organization that explicitly is made to pay the legally enforceable pledge of a donor is treated as a gift from the third-party to the donor and then a charitable contribution from the donor to the charitable organization. A deemed gift or distribution by a DAF to the pledge-making donor under the first leg of the Revenue Ruling’s analysis could trigger the tax under Section 4966. Because the Notice is expressly limited to the Section 4967 excise tax, it arguably does not prevent the application of the Section 4966 excise tax. The same may be expected of proposed regulations once issued.
Until this apparent oversight is corrected, we recommend DAFs not make distributions to satisfy legally enforceable pledges by DAF donors, advisors, or related parties.
DAF distributions to publicly supported charities
DAF distributions to publicly supported charities are deemed to come from the DAF donor for purposes of public support testing. Under the mathematical test, by which most public charities avoid classification as private foundations, such charities must raise one-third of total support (i.e., total revenue) from public contributions on a five-year, rolling, cumulative basis. In the case of large donations by a single donor or group of related donors, not more than 2% of total support may be counted as public support unless the donor is, itself, a publicly supported charity or a governmental entity.
Because most DAF sponsoring charities are publicly supported charities, under existing law DAF distributions are usually not subject to the 2% limitation. This proposed regulation requires a public charity receiving a DAF distribution to treat the distribution as coming from the DAF donor (usually an individual taxpayer or a private foundation), rather than from the DAF sponsoring charity. The result is that the distribution is subject to the 2% limitation. Additionally, publicly supported charities are required to treat all anonymous contributions (and DAF distributions for which the sponsoring organization fails to identify the DAF donor) as being made by one person – again subject to the 2% limitation.
We do not know when or whether these proposed regulations will be issued or what the effective date will be. DAF advisors and sponsoring charities of DAFs that support public charities for whom avoiding the 2% limitation of the public support test is important should consider initiating the process of making DAF distributions early in the year so as to increase the chances that the distribution occurs before the effective date of any proposed regulations subsequently issued.
Although no regulations are proposed on this point, private foundation transfers to DAFs are under scrutiny. The Notice invites public comments and suggestions on (1) how private foundations use DAFs in support of the foundations’ purposes and (2) whether a transfer of funds by a private foundation to a DAF should be treated as a “qualifying distribution” only if the DAF sponsoring organization agrees to distribute the funds for charitable purposes within a certain timeframe. This invitation appears to respond to the allegation that private foundations are using donor advised funds to satisfy the Section 4942 requirement to disburse approximately 5% of net asset value per year, without really putting the disbursed funds into the hands of operating charities to fund charitable activities.
This invitation may portend further regulation on the subject. Private foundations already considering funding a DAF expected to hold transferred assets for an extended period of time may wish to consider accelerating such plans.
Comments on these issues may be submitted to the IRS by March 5, 2018.
Please contact Withers if we may be of service in navigating how this notice affects you or your organization.