Industry awaits an answer on proposed donor-advised fund regulations

Now that the comment period over the IRS’ proposed regulations for donor-advised funds has ended, the waiting game has begun – along with a whole lot of simmering criticism.

Last November, the Treasury Department and the Internal Revenue Service proposed regulations fundamentally redefining DAFs. The agencies accepted letters and comments from industry participants on their proposal until February 15 and will be reviewing those responses in coming months before making their final decisions likely later this year.

A DAF is a fund that encourages and accelerates charitable gift-giving by donors. Donors make irrevocable contributions to DAFs and then are allowed to provide nonbinding advice to the sponsoring organization on further distributions to qualified charities. As of 2022, more than $228 billion in assets were held in DAFs, according to the National Philanthropic Trust.

The proposed regulations impose a 20% excise tax on a sponsor that makes a taxable distribution – a distribution to a person or a group that’s not a qualified charity  – from a DAF, and a 5% excise tax on a fund manager who knowingly agrees to make a taxable distribution. They also address a number of definitional issues related to DAFs and drill down on the types of distributions that will in turn trigger those taxes.

THE INDUSTRY WEIGHS IN

More than 100 individuals and organizations submitted comments expressing their concerns over the proposed regulations, including Amy Freitag, president of the New York Community Trust, which created the first DAF in 1931 and has operated thousands of DAFs in the decades since.

Freitag lobbied against the new rules in a letter to Bloomberg late last month, saying she was concerned the rules will make DAFs more expensive and unwieldy for community foundations to manage, thereby deterring potential donors from establishing DAFs at community foundations.

“We are also concerned that the proposed regulations will add substantial and vague new compliance obligations which will add to our costs, create new and needless risks of non-compliance, and limit the ability of community foundations to work with donors in ways that promote volunteerism, community engagement, and innovation,” Freitag wrote.

Rachel Schnoll, CEO of the $2.8 billion Jewish Communal Fund, expressed similar concerns that the proposed regulations regarding DAFs may require significant operational changes for DAFs and donors. In particular, she worries that this proposal would inhibit financial advisors from being paid to offer investment advice to a DAF donor. Advisors are currently free to select a DAF that is a good fit for their clients’ values and philanthropic needs.

“If advisors may no longer be paid for their investment advice with respect to assets maintained in a community foundation or single-issue DAF, personal investment advisors may be incentivized to only recommend DAFs offered by the financial institutions that employ them, and those institutions may be incentivized to invest DAF assets in their firm’s proprietary funds for which the financial institution is compensated,” Schnoll said.

Speaking from the advisory side, Roshan Weeramantry, co-head of wealth management at Helium Advisors, takes to heart Schnoll’s reservations about advisors remaining fee-free when it comes to DAFs.  

“As a firm, we've long believed that assisting our clients in establishing and managing donor-advised funds is a value-added service, for which we do not charge fees,” Weeramantry said. “Our goal is to ensure that the maximum amount possible goes directly to the charities our clients care about."

Richard Austin, executive director at Integrated Partners, says many of the high-net-worth clients he works with use donor-advised funds as an alternative to private foundations. After reviewing the proposed regulations, he believes these clients should see no impact.

That said, he does have concerns that his clients who work closely with community organizations could “inadvertently be subject to the excise taxes within the proposed regulations.”

LAWYERS OPINE, TOO

Andrew Grumet, lawyer at Holland & Knight, said his clients appreciate the goverment's efforts to create greater clarity under the law. However, he says the proposed regulations as written fail to accurately take into account how charities operate. For example, they don't consider the robust systems already in place to “root out bad actors and ensure charitable dollars are used for charitable purposes.

“Just as dollars flowing into DAF programs have grown exponentially in the past 15 years, so too has the level of sophistication with which sponsoring organizations operate,” Grumet said. “The mismatch between the proposed regulations and the plain facts of how sponsoring organizations operate today creates a chasm between intent and application.”

When it comes to the issue of better defining DAFs, Stuart Weichsel, trusts and estates attorney at Gallet Dreyer & Berkey, believes that the proposed regulations would indeed provide some clarity. They would also provide some important clarifications on the penalties that apply to taxable distributions to recipients who are not traditional qualified charities, Weichsel said.

Nevertheless, while the proposed regulations offer some important details regarding the operations of DAFs, he still believes the majority of DAFs operating through major banks and brokerage houses won't see any impact should these regulations be finalized.

“The major DAF operators already have procedures in place that guard against any of the issues raised by the new proposed regulations, so donors to DAFs will not notice any change,” said Weichsel.