Should Congress Curb Donor Advised Funds?

By :: April 22nd, 2014

Buried deep in House Ways & Means Committee Chair Dave Camp’s tax reform plan is a proposal to require donor-advised funds to distribute contributions within five years. The proposal would be a major change for these charitable vehicles, where funds currently can sit indefinitely.

Donor-advised funds (DAFs) are an easy, low-cost way for people (who tend to be upper middle-class but not super-rich) to both shelter income and give to their favorite charities. And they have been booming. In 2012, according to the National Philanthropic Trust, these funds held more than $45 billion—nearly as much as the Gates and Ford foundations combined. Contributions were up by one-third over 2011. Think of them as mini private foundations for the merely wealthy, though middle-class people can certainly participate.

They work like this: You set up a fund with a broker or mutual fund company, or with a non-profit community foundation. Each year you can instruct the fund to distribute a portion of your contribution to your favorite charity. However, you can immediately deduct your contributions even before they are distributed.

As with other charitable gifts, you can avoid paying capital gains taxes by contributing appreciated stock or other property to the fund. And you get an extra benefit: You can transfer a single large piece of appreciated property (say, a rental house) to the DAF and then sell it and give the proceeds to many different charities without having to pay capital gains taxes.

Unlike private foundations, DAFs have no minimum distribution rules. Your contributions can sit with your broker or community foundation in perpetuity and never have to be distributed to charities. The managers of the funds collect annual fees for holding and distributing the money.

Camp would require funds to pay out contributions within five years of receipt. Undistributed assets would be hit with a stiff 20 percent excise tax.

Are these funds a tax shelter or an effective tool to encourage well-off (but not rich) Americans to contribute more to charity? The answer may be both.

Supporters note that annual payouts from DAFs average about 16 percent, more than three times the minimum 5 percent distributions required of private foundations (which tend to treat that target as a ceiling as well as a floor). They note that there are no set-up fees and that annual management fees are relatively low (1.1 percent for community foundations and about 0.6 percent or less for brokers—plus investment expenses).  Minimum contributions are usually about $5,000.

Their big argument is that these funds can democratize endowed giving by making a private foundation-like mechanism available to middle-income people. This allows them to smooth their giving by contributing relatively large amounts to their DAF in fat years and smaller amounts in thin ones, and in fact increases charitable contributions overall.

The Manhattan Institute’s Howard Husock made a nice case for the funds in a March 28 piece on Forbes.com: “Donor-advised funds, because of their scale and potential for substantial growth, may provide a new model for addressing America’s social needs.”

But critics don’t buy it. Boston College law professor Ray Madoff calls DAFs “charitable checking accounts.” In a January article in the Journal of Philanthropy, she wrote, “…donors and the people who manage their money have been the primary recipients of benefits from the growth of donor-advised funds, while charities and the people they serve are being starved of resources.”

She argues that despite the growing popularity of DAFs, there has been no increase in charitable giving. In fact, she says the ability of people to shelter income by shifting assets to DAFs rather than giving directly to charities may even have reduced contributions to charities themselves.

While I have some sympathy for Husock’s argument, his democratization claim has limits. We don’t know much about the incomes of people who set up DAFs but we do know each fund holds an average of about $225,000.

Thus, DAFs do make it possible for many more people to set up charitable funds, but the biggest tax beneficiaries are still quite likely to be high-income households.

Some form of minimum payout rule seems to make sense though there is nothing magic about Camp’s five years. However, my Tax Policy Center colleague Gene Steuerle asks another question: If policymakers are so worried about sheltering, why impose a five-year distribution rule only on DAFs and not on private foundations as well? If the goal is to make sure funds end up the in hands of charities, why stop with DAFs?

 

 

7Comments

  1. Michael Bindner  ::  11:50 pm on April 22nd, 2014:

    One other thing comes to mind. How many of these funds give to other family funds and trusts while avoiding such things as the gift tax? Is it even possible to know? It would certainly take some digging into 990s, provided DFA’s even file this form. I can see why Camp inserted this, but he makes no friends in doing so as far as the passage of his tax reform bill – which is looking like a really good class project and less like anything that can pass. I would prefer the kind of tax reform I and Michael Graetz propose. The only definite tax break I would include is for the transfer of funds to a broad based ESOP. Charitable contributions may be deductible, but income cashed out from an inherited asset or directly transferred would be taxed as normal income – as would gifted income and assets, including DFAs.

  2. Tax Roundup, 4/23/14: The Tax Fairy isn’t named “VEBA.” « Roth & Company, P.C  ::  10:10 am on April 23rd, 2014:

    […] Gleckman, Should Congress Curb Donor Advised Funds?  They are a much more convenient and cost-effective than their alternative, private foundations, […]

  3. Dave Camp’s Tax Reform Could Kill Community Foundations  ::  2:02 am on April 25th, 2014:

    […] are legitimate concerns over how such donor advised funds should be regulated. It may even be possible to design a proposal […]

  4. Steven Woolf  ::  2:17 pm on April 28th, 2014:

    Donor advised funds are an essential charitable giving vehicle for many sponsoring organizations. Many Jewish federations serve this function for their donors and are extremely proud of the chartiable accomplishments that have been achieved throught their stewardship. (Collectively, Jewish federations are sponsoring organizations of over $4 billion in DAF assets and annually distribute approximately 18-20 percent of such assets to qualified charities.)

    DAFs are an essential component of Jewish federation’s mission to inspire Jews to fulfill their religious duty to be charitable, help secure the financial and human resources necessary to care for those in need, rescuing Jews in danger, and, in no small part, ensure the continuity of the Jewish people. They offer an efficient and economical means for a donor to benefit the community and encourage family philanthropy, often enabling such donors to better identify their charitable goals and interests.

    In addition to providing financial resources for critical human services in the local Jewish and general communities, DAFs also advance the values and goals of the federation system through:
    (1)Nurturing relationships between Jewish philanthropists and federation lay and professional leadership;
    (2) Building leadership and social capital within the Jewish community, helping to groom the next generation for key positions in federations and affiliated agencies;
    (3) Establishing and validating programmatic priorities that consider the current and future needs of the Jewish community;
    (4) Reinforcing the positive perception of the federation as a philanthropic partner within the larger community; and
    (5) Helping to meet the annual funding needs of federations and their agencies. To this last point, it is worth noting that in many Federation communities, these funds operate to provide almost one-fifth of the funds of the “annual campaign,” which continues to be the most important fundraising activity conducted in the Jewish philanthropic world.

    Another way of telling the DAF story is to focus on who benefits from these vital giving vehicles. First, the Jewish community and its philanthropic and social service mission benefit because they provide a reliable pool of dollars to fund a variety of social service activities. Recently, one large federation tapped its DAF donors to fund a shortfall in Federal funds for kosher meals to seniors that fell subject to arbitrary sequestration budget cuts.

    Some may question the value of “charitable checking accounts,” but we at the Jewish federations would invite those critics (and Chairman Camp) to examine the life-saving work that DAFs help accomplish, each and every day.

  5. Sue Santa, Council on Foundations  ::  9:47 am on April 29th, 2014:

    Critics of donor advised funds focus on their immediate tax benefit to the individual and the possibility of a delayed benefit to the community. While it can be interesting to analyze an individual giving tool, when we step back, we have a bigger question to answer – do we want donors to have more opportunities to donate to charitable causes or less opportunities?

    Our charitable sector thrives because donors get to choose to donate their money to diverse causes in diverse ways. Some choose to give a one-time gift to one or more charitable organization. Others choose to set up a private foundation and create a long-term strategy for their giving. Still others choose to use a donor advised fund so that they can decide on their charitable gifts with the support and guidance of a public charity’s staff such as a community foundation. Generous donors may use a combination of these giving vehicles to see that numerous charitable organizations receive funding for new projects as well as organizational sustainability.

    Donor advised funds are one of many charitable giving opportunities. They enable donors to make sustained, strategic investments in their communities. They can be started quickly to respond to tragedy, as in the case of a natural disaster or the closing of a large employer within a neighborhood. They also allow donors to build upon their giving year-over-year, to pool funds with other donors, and to direct that giving to causes important to their communities, providing impact not only immediately but over time. Donors work with professional staff at the foundation hosting their funds to leverage their donor advised fund to do more for the communities they love and are in need.

    At the Council on Foundations, our membership of grantmaking foundations and programs is heartened by the growth and popularization of any and all charitable vehicles that promote philanthropic giving. Charitable giving, through any financial vehicle or donation, is much more than just a tax deduction.

  6. James Shott  ::  3:15 pm on April 29th, 2014:

    I am Executive Director of a small community foundation, with assets of about $4.5 million. We have a number of DAFs, and none of them are as large as the cited average of $225,000, and most less than $50,000.

    These funds have been started by people who are not wealthy, as are most DAFs, but the earnings on the fund assets are distributed annually, in most cases. The grants from these funds usually are between $500 and $1,000. These small amounts are quite useful to the recipients in our communities.

    I see no sense in changing tax law to require these funds to be dissolved. They are not a tax dodge for the donors, and they do not provide much beyond the cost of maintenance to the foundation.

    Leave well enough alone for such funds, and allow the donors to continue helping their community through grants of a few hundred dollars each year.

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