As 2020 ended and Americans reflected on the struggles of the past year, it became clear how many Americans rely on charities to serve critical needs – whether it be health care, education, food assistance, shelter, or social justice reform. While charities struggled to keep up with the rising demand of their services, design flaws in our tax system have allowed more than $140 billion to sit in donor-advised funds (DAFs) instead of in the hands of working charities. Below are frequently asked questions about DAFs and how IACG’s policy reforms can help address the shortcoming in our tax code and get money to working charities, faster.
What is a donor-advised fund?
A donor-advised fund (DAF) is a financial vehicle that lets donors give to a charitable sponsor, which holds and invests the funds in a separate account until the donor decides at some future date to advise grants out. When a donor funds their DAF, they receive an upfront tax benefit. DAFs are an important charitable giving tool and play a vital role in supporting the place-based, mission-driven organizations, such as community foundations.
What are the problems with the current rules around donor-advised funds?
The conventional idea of a charitable gift, and the one traditionally supported by the tax code, is that a donor parts with their money by making what might be called an outright gift to charity. With a true outright gift, the charity has complete control over use of the funds. DAFs, however, allow donors to keep effective control of funds through advisory privileges, which can even be passed on to a donor’s heirs.
Current tax law provides an upfront tax benefit when a donor puts money in a donor-advised fund. All the tax benefits – income tax deduction, capital gains exclusion, and estate tax benefits – are tied to giving to the DAF, not distributing from the DAF. Simply put, there is no incentive or requirement for donors ever to advise grants from their funds. While some DAF accounts pay out quickly and robustly, many do not. The payout numbers reported by DAF sponsors are averages across all DAF accounts, thus allowing low paying accounts to free ride for payout purposes off of higher paying accounts.
How will IACG’s reforms address the loopholes around DAFs?
IACG wants to encourage distributions from donor-advised funds and it makes sense to tie giving incentives – the income tax deduction – to the desired behavior – the paying out of funds to the working charity. We propose two options for DAF donations: payout in 15 years or align the tax benefit with the distribution of funds to charities. We want to provide flexibility for the donor, but still incentivize giving to working charities. So, if a donor prefers to get a tax deduction in the year of gift to the DAF, but advise their contributions in a future year, they would have that option by agreeing to advise all contributions and earnings within 15 years. If a donor would prefer to give their money over a period of time longer than 15 years, they would elect to have an aligned benefit rule, receiving the income tax deduction when the funds are distributed to charity.
With these rules in place for donor-advised funds, we can address the design flaws in the charitable tax laws and accelerate giving to charities. Every donor-advised fund account would have an incentive or requirement in place to fulfill their purpose: making grants to charities.
Learn more about IACG’s policy proposals here.