The Internal Revenue Service proposed new regulations for donor-advised funds (DAF) this month. Specifically, the IRS seeks to delineate what constitutes a DAF and what does and does not count as a tax-exempt distribution from one.

DAFs allow donors to receive an immediate tax deduction for irrevocably donated funds that may be invested, grown, and distributed to charities. The National Philanthropic Trust (NPT) released its 2023 DAF report the same week as the IRS rulemaking, and its latest data underscores the ongoing popularity of these giving vehicles. Specifically, nearly two million DAF accounts now hold $228.89 billion in assets. Those accounts granted $52.16 billion to charities in 2022 – a new high and 9 percent more than in 2021. That is equivalent to a 22.5 percent payout rate, continuing an annual pattern of payout rates of more than 20 percent each year the NPT has tracked them.

While some critics in Congress want to legislate additional payout and disclosure rules for DAFs (see this relevant ECFA article), this month’s IRS rulemaking addresses more fundamental questions defining a DAF and clarifying what distributions are taxable and subject to excise taxes. 

DAFs must meet a three-pronged test by which they are separately identified for contributions, owned and controlled by a sponsoring organization, and are expected to be advised by at least one donor. Some exceptions under the IRS rules include accounts distributed only to a single organization and some scholarship and disaster-relief funds. The agency’s proposal also notes that charitable gifts simply earmarked for a specific program do not constitute ongoing advisory privileges for a donor (thus not triggering DAF rules), but the rulemaking does seek public comment on when a gift agreement could effectively create a DAF. 

Taxable distributions–generally those not going to charitable purposes–are subject to an excise tax of 20 percent on sponsoring organizations and 5 percent on fund managers. In its rulemaking, the IRS defines such distributions broadly as “any grant, payment, disbursement, or transfer, whether in cash or in kind.” The agency proposes an anti-abuse framework to make sure donations are not funneled for purposes inconsistent with DAFs, and it specifically calls out distributions for non-charitable activities like political campaign work and lobbying on legislation as taxable. However, investments and “reasonable investment and grant-related fees” would not be taxable distributions.

More details from the IRS are available in the Federal Register. The IRS invites comments on this proposed rulemaking through January 16, 2024.