IRS Provides Guidance Regarding the Use of Donor Advised Funds to Satisfy Pledges and Addresses Other Donor Advised Fund Questions

On December 4, 2017, the IRS issued Notice 2017-73 (the Notice), which describes, and requests comments on, proposed guidance that the IRS and Treasury are considering with respect to donor advised funds (each, a DAF). Specifically, they are considering developing proposed regulations under Section 4967 of the Internal Revenue Code (the Code) that would facilitate DAF distributions in fulfillment of charitable pledges made by donors, donor advisors, or related persons (each, a Donor/Advisor); make significant changes to the public support test rules for grantees of DAF distributions; and address DAF distributions in exchange for which a Donor/ Advisor receives certain goods or services (e.g., tickets to an event). The IRS and Treasury anticipate that any proposed regulations they issue also will address the application of excise taxes where a distribution is potentially subject to tax under both Sections 4958 and 4967 of the Code. These proposals are described in greater detail below. The full text of the Notice is at this link.

Fulfillment of A Donor/Advisor’s Pledge

Section 4967 of the Code imposes excise taxes when a donor advisor advises a DAF to make a distribution that directly or indirectly confers more than an incidental benefit upon a Donor/Advisor. The excise tax is imposed on any Donor/Advisor who advises as to the distribution or who receives the benefit as a result of the distribution, as well as on any fund manager who agrees to make the distribution knowing that it confers more than an incidental benefit upon a Donor/Advisor. Prior to the Notice, it was not clear whether a donor advisor may advise a distribution from a DAF to satisfy a Donor/Advisor’s pledge to make a contribution to a charity. The concern was that the DAF’s satisfaction of the Donor/Advisor’s pledge would be considered a prohibited benefit to the Donor/Advisor, just as a private foundation’s grant or other payment in fulfillment of the legal obligation of a disqualified person generally would be considered a prohibited act of self-dealing.

The Notice delivers some clarity, providing:

distributions from a DAF to a charity will not be considered to result in a more than incidental benefit to a Donor/Advisor under § 4967 merely because the Donor/Advisor has made a charitable pledge to the same charity (regardless of whether the charity treats the distribution as satisfying the pledge), provided that the sponsoring organization makes no reference to the existence of any individual’s pledge when making the DAF distribution. [Emphasis added.]

Specifically, certain distributions from a DAF that the recipient charity treats as fulfilling a Donor/Advisor’s pledge would not result in a more than incidental benefit under Section 4967 of the Code, regardless of whether the pledge is legally enforceable, provided that the following requirements are met:

(a)   the sponsoring organization makes no reference to the existence of a charitable pledge when making the DAF distribution;
(b)   no Donor/Advisor receives, directly or indirectly, any other benefit that is more than incidental on account of the DAF distribution; and
(c)  no Donor/Advisor attempts to claim a charitable contribution deduction with respect to the DAF distribution.

Quarles & Brady Comments: 

Although the Notice provides some clarity regarding the use of a DAF to fulfill a Donor/Advisor’s charitable pledge, certain issues remain. The Notice, for example, expressly provides that “this special rule regarding charitable pledges would apply for purposes of § 4967 only,” and that the “principles discussed in this section … would not be intended to affect the tax treatment of any item under any [other] provision of the Code.” Accordingly, it is unclear whether a DAF’s fulfillment of a legally enforceable pledge of a Donor/Advisor could give rise to penalties under Section 4958 of the Code, which imposes excise taxes on certain excess benefit transactions between a charitable organization and any of its “disqualified persons”. 

Additionally, it is unclear what steps, if any, a Donor/Advisor may take to ensure that the grantee actually counts the DAF distribution toward the Donor/Advisor’s pledge. For example, may a donor have entered into a pledge agreement providing that any payment to the recipient charity from a DAF established or advised by the donor will be deemed to be a payment toward the pledge? Or may the donor, at the same time as the advice is provided to the DAF sponsor, notify the recipient charity that any payment pursuant to that advice should be treated as a payment toward the pledge? 

The Notice appears to focus on the impracticality of requiring the DAF (i.e., the sponsoring organization of the DAF) to know whether or not its distribution is in satisfaction of a legally enforceable pledge made by its Donor/Advisor and concludes that as long as the agreement between the DAF and the recipient charity does not reference any charitable pledge, the DAF need not dig further to ensure that the payment is not in satisfaction of a pledge. That might suggest that the eventual regulations will be more protective toward the sponsoring organization than toward Donor/Advisors whose pledges are satisfied pursuant to their specific agreements with the recipient charities.

While it may seem unfair to issue this Notice giving comfort as to pledges and then to apply a tax in the same situation under a different Code section, there may be different policy implications if the Donor/Advisor is otherwise a disqualified person with the respect to the sponsoring organization of the DAF (e.g., a director of the sponsoring organization). It is possible the IRS and Treasury might decide that situation is closer to the private foundation situation and that the excess benefit transaction rules of Section 4958 should apply even if Section 4967 does not apply.

The Notice provides that taxpayers may rely on this guidance regarding pledges immediately and until additional guidance is issued. Until the issues identified above are resolved, however, we believe Donors/Advisors should proceed with caution. Donors/Advisors also should keep in mind that many sponsoring organizations require an advisor to check a box or otherwise confirm that the distribution being advised is not in satisfaction of a pledge. That usually is tied to the sponsor’s rules or policies. Until those sponsoring organizations change this requirement (including any check-box), their Donors/Advisors are not likely to benefit from the Notice.

Public Support Computation

The proposed guidance also would provide that, in computing its public support percentage, a recipient charity must treat (a) a distribution from a DAF as coming from the donor(s) that funded the DAF, rather than from the sponsoring organization; (b) all anonymous contributions received as being made by one person; and (c) distributions from a sponsoring organization as public support without limitation only if the sponsoring organization specifies that the distribution is not from a DAF or states that no Donor/Advisor advised the distribution.

Quarles & Brady Comments:

The IRS and Treasury consider this an anti-abuse measure. The public support test rules generally allow a charity to count as public support the full amount of any grants and contributions received from public charities described in Section 170(b)(1)(A)(vi) of the Code (a Donative Public Charity). Contributions and grants from certain other sources, such as individuals, private foundations, and non-charitable entities, are counted as public support only to the extent that the aggregate support from each such donor and certain persons related to the donor does not exceed two percent (2%) of the charity’s total support (the 2% Limitation) during the period reported.

Because of the contributions they receive from the general public, DAF sponsoring organizations typically qualify as public charities described in Section 170(b)(1)(A)(vi) of the Code whose distributions would be counted in full as public support of their grantees. Accordingly, a contribution that would be subject to the 2% Limitation if received directly from the donor typically can escape the 2% Limitation and be counted in full as public support if received from the donor’s DAF instead. The proposed guidance would eliminate this disparity and make maintaining public charity status more challenging for certain grantees that receive DAF distributions. It should not adversely affect DAF distribution recipients such as hospitals and universities that do not rely on public support to maintain their public charity status.

Charity Events and Membership Fees

The Notice further provides that distributions from a DAF for the purchase of tickets that enable a Donor/Advisor to attend or participate in a charity-sponsored event result in a more than incidental benefit to the Donor/Advisor under Section 4967 of the Code, even where the Donor/Advisor pays the nondeductible portion of the ticket price. The same analysis would apply with respect to membership fees and member benefits. As the Notice points out, a “Donor/Advisor who wishes to receive goods or services (such as tickets to an event) offered by a charity in exchange for a contribution of a specified amount can make the contribution directly, without the involvement of a DAF.”

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This update is intended as a general summary of legal matters and not as specific advice to any particular client. If you have any questions concerning the subject matter of this update, please contact Jodi (Pellettiere) Patt at (312) 715-5063/jodi.patt@quarles.com, Janice E. Rodgers at (312) 715-5034/janice.rodgers@quarles.com, Patricia M. Spiccia at (312) 715-5284/patricia.spiccia@quarles.com, or your Quarles & Brady attorney.