Key Senators Introduce Legislation Proposing Reforms to Donor-Advised Funds and Private Foundations
On June 9, 2021, Senator Angus King (I-ME) and Senator Charles Grassley (R-IA) introduced the Accelerating Charitable Efforts (ACE) Act (S. 1981). The bipartisan legislation would impose several new restrictions and administrative costs on donor-advised funds (DAFs) and additional restrictions on private foundations.1 The legislation aligns with the proposals advanced by the Initiative to Accelerate Charitable Giving,2 the robust lobbying campaign led by philanthropist John Arnold. The Initiative argues that these proposals would resolve inefficiencies in our tax laws and ensure that funds flow faster to charities.
Under present law, a donor is allowed an immediate year deduction for a contribution to DAFs in the amount of the contribution and exercises advisory privileges over the timing and recipient of distributions from the DAF. The Act generally separates DAFs into two groups: 15-year DAFs, which must distribute contributed funds within 15 years, and 50-year DAFs, which must distribute contributed funds within 50 years. The Act imposes restrictions on both 15- and 50-year DAFs regarding the timing and amount of deductions donors are allowed in connection with contributions and the restrictions on 50-year DAFs are particularly onerous. The Act also proposes new rules regarding the interaction between DAFs and other public charities and between DAFs and private foundations. Finally, the Act aims to incentivize increased and quicker distributions by private foundations.
Taken together, the proposed reforms would significantly restrict the flexibility of charitable giving that the current tax system allows.
I. Types of DAFs Under the Act
A. 15-Year DAFs
Fifteen-year DAFs—referred to in the legislation as "Qualified DAFs"—are DAFs that impose a 15-year limitation on that advisory privileges that a donor may exercise over a particular contribution.3 That limitation must be memorialized in the DAF's governing documents and the 15-year DAF is required to "trace" the contributed funds on a first-in, first-out basis to ensure they are distributed within 15 years.
Under the Act, donors generally remain eligible for a deduction for the tax year of a contribution to a 15-year DAF. However, the Act proposes special rules for contributions of non publicly traded assets, such as closely held securities, real estate, or art, to 15-year DAFs. First, a donor is not allowed a deduction for a contribution of a non-publicly traded asset until the sponsoring organization sells the asset. Second, the amount of the deduction is limited to the amount of the sales proceeds recognized by the sponsoring organization. Finally, no deduction is allowable unless the sponsoring organization provides to the donor a written acknowledgement of the contribution within 30 days of the funds being credited to the donor's account that sets forth the amount of proceeds credited to the donors account and states that the donor's deduction is limited to that amount. Certification statements to this effect must be provided to both the Internal Revenue Service (IRS) and the donor for the deduction to be allowed.
If a 15-year DAF fails to distribute a contribution within 15 years, it is subject to a 50 percent penalty on the undistributed amount of the contribution.
We note that this rule will impose significant administrative burdens on DAFs, in particularly with respect to the requirement to trace contributed funds to make sure they are distributed within the 15-year period and to issue the required certifications. In addition, DAFs will feel pressure to sell complex assets as quickly as possible to facilitate the donor's deduction. Flexibility for donors is also reduced, because now distributions must be recommended within 15 years.
B. 50-Year DAFs
Fifty-year DAFs—also called Nonqualified DAFs—are DAFs that are not 15-year DAFs. The Act's provisions relating to 50-year DAFs propose a change to a central premise of DAFs. Under the Act, donors are not allowed a deduction for a contribution to a 50-year DAF until the DAF makes a distribution from the contribution to a charitable organization.4 This rule would apply to contributions of any asset—whether liquid or illiquid—to a 50-year DAF. The amount of a deduction to 50-year DAFs is limited to the amount of the distribution. For purposes of tracing funds, such distributions are treated as being made from contributions on a first-in, first-out basis.
Additionally, donors are not allowed a deduction for any contribution of a noncash asset to a 50-year DAF until the DAF sells the property. This rule would apply to both publicly traded securities as well as closely held securities and illiquid assets. Thus, donors that contribute non-cash assets to a 50-year DAF must wait until the DAF sells the property and distributes it before they can take the resulting deduction. Like 15-year DAFs, 50-year DAFs must also provide a written statement upon the sale of non-cash assets that sets forth the amount of proceeds credited to the donors account and states that the donor's deduction is limited to that amount. Unlike 15-year DAFs, the asset restriction applies not only non-publicly traded assets but to any asset other than cash. It is not clear under the proposed legislation how certain cash equivalents will be treated.
Certification statements reflecting both the distribution and, if applicable, the sale of non-cash assets must be provided to both the IRS and the donor for the deduction to be allowed. If a 50-year DAF fails to distribute a contribution within 50 years, it is subject to a 50 percent penalty on the undistributed amount of the contribution.
Because of the delay on deductions, we expect that few donors are likely to prefer a 50-year DAF. On the sponsoring organization side, significant administrative burdens arise due to the tracing and certification requirements.
C. Community Foundation DAFs
The Act also creates a third type of DAF: a "Qualified Community Foundation DAF." A Qualified Community Foundation DAF is generally any DAF that is (1) owned by a qualified community foundation and (2) limits advisory privileges to DAF accounts that have an aggregate value of at most $1 million. A qualified community foundation is defined in the Act as a section 501(c)(3) organization that is created to serve a geographical area no bigger than four states by pooling donations in charitable funds and that holds at least 25 percent of its total assets outside of DAFs.5 A DAF with an aggregate value over $1 million that is owned by a qualified community foundation, can still be treated as a Qualifying Community Foundation DAF if its governing documents require annual qualifying distributions in an amount equal to at least five percent of the value of the DAF.
Qualified Community Foundation DAFs are generally subject to the same rules as 15-year DAFs, but they are not subject to the 50 percent penalty.
II. DAFs, Public Charities, and Private Foundations
The Act proposes new rules regarding the interaction between DAFs and both public charities and private foundations.
A. Distributions from DAFs to Other Public Charities
The Act imposes a disclosure requirement on public charities that receive contributions from DAFs. Generally, contributions from a DAF-sponsoring organization will not be treated as being made by an organization in section 170(b)(1)(A) for purposes of determining the level of a public charity's public support for purposes of the tests set forth in sections 509(a)(1) and (a)(2), which generally require 33.3 percent of a public charity's support be from certain "public" sources (including, generally, other public charities). Therefore, contributions from DAFs generally will not be treated as being made by the public and all such contributions are treated as being made by a single disqualified person. Nevertheless, a distribution from a DAF will count towards a public charity's public support if the DAF sponsoring organization identifies the donor that recommended the contribution or certifies that the contribution was not made by a DAF and that no person exercised any advisory powers over the contribution.
The clear purpose of this rule, as advocated by the supporters of the Act, is to prevent donors from using DAFs as an "end run" around the public support rules. Public charities that receive significant support from DAFs will have to revisit their public support fractions and consider whether to take on the administrative burden of determining whether those DAF contributions can be "looked through" via certification to determine if they come from a non-disqualified individual (and therefore still count toward the public support test).
B. Distributions from Private Foundations to DAFs
Under current section 4942, a private foundation that does not satisfy the minimum distribution requirement (i.e., an amount generally equal to five percent of the fair market value of the foundations non-charitable use assets, unless an exemption applies) must pay a 30 percent tax on the undistributed amount. Under the Act, a distribution from a private foundation to a DAF would no longer be treated as a qualifying distribution for purposes of meeting its minimum distribution requirement, unless the DAF distributed the funds received to a qualifying recipient (e.g., a section 501(c)(3) organization that is not a DAF or non-operating private foundation) by the end of the taxable year following the year of the initial distribution. The Act also imposes an additional reporting obligation on private foundations, requiring them to report the amount of contributions to DAFs in a taxable year, the sponsoring organization of any DAFs to which it contributed, and any advice given to the sponsoring organization.
III. Private Foundations
Finally, the Act proposes to restrict private foundation spending and to encourage for private foundations to quickly distribute contributed funds.
The Act prohibits a private foundation from counting administrative expenses, which include items such as salary or travel expenses, towards its minimum distribution requirement if made to certain people, including substantial contributors, foundation managers, and their family members. The Act contains an exception for administrative expenses paid to a foundation manager (typically an officer or director of the foundation), provided that the foundation manager is not a relative of a substantial contributor or anyone who owns more than 20 percent of an entity that is a substantial contributor.
The Act also exempts from the net investment tax in section 4940 private foundations that commit to making significant distributions to qualified recipients. Under current section 4940, private foundations are generally subject to a 1.39 percent excise tax on their net investment income realized in a taxable year. The Act proposes to exempt from the net investment tax foundations that meet one of two tests. First, a private foundation will be exempt from the net investment income tax if it makes qualifying distributions of at least seven percent of the excess of the aggregate fair market value of the foundation's assets over the aggregate debt obligation with respect to those assets. Second, a private foundation will be exempt from the net investment income tax if, from the time of its establishment, it includes in its governing documents a provision limiting the life of the foundation to 25 years and that makes no distributions to disqualified private foundations. A private foundation that is exempt from the net investment income tax the second test will be subject to a recapture tax if it is subsequently found to be in violation of either of its two prongs.
IV. Effective Date
The provisions of the Act pertaining to the timing and amounts of deductions in connection with contributions to DAFs are effective for contributions made after the date on which the Act is enacted. Similarly, the 50 percent penalty on the failure to distributed contributed funds is also effective for contributions made after the of enactment.
The treatment of distributions from private foundations to DAFs is effective for tax returns filed after December 31, 2021. The treatment of contributions from DAFs to public charities is effective as to contributions made in taxable years beginning after the date of enactment. The rules pertaining to private foundations are effective for taxable years beginning after the date of enactment.
V. Legislative Outlook
The legislative calendar for the remainder of 2021 is shaping up to be very active. Congress is expected to consider significant tax legislation toward the end of year, which could provide a legislative vehicle for the ACE Act to be considered. The Act's prospects are still yet to be determined, but its supporters are certainly going to continue to actively target policymakers to advance their proposals. Also, Senator Grassley is a senior member of the Senate Finance Committee and will be a key player as tax legislation gets developed. For these reasons, it is important to closely monitor these proposals.
Miller & Chevalier welcomes the opportunity to work with DAFs and their sponsoring organizations, private foundations, and donors to evaluate how the proposed rules would apply to them and make sure their concerns are presented during the legislative process.
For more information on the ACE Act, please contact:
1Senator King is an independent but caucuses with Democrats in the Senate. The text of the legislation is available here.
2Additional information on the Initiative to Accelerate Charitable Giving is available here.
3The Act requires that a DAF's governing documents provide that advisory privileges with respect to a contribution terminate 14 years after the end of the taxable year in which the donor made the contribution.
4The Act requires that a DAF's governing documents provide that advisory privileges with respect to a contribution terminate 49 years after the end of the taxable year in which the donor made the contribution.
5All section references are to the Internal Revenue Code of 1986, as amended and currently in effect.
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