Written by Kathryn H. Crary, Esq., Gadsden Schneider, & Woodward LLP
kcrary@gsw-llp.com

The exponential growth in the popularity of donor advised funds or “DAFs” over the past several decades has led to increased scrutiny from the media, Congress, and most recently the Internal Revenue Service. In November 2023, the IRS published proposed regulations at REG-142338-07 regarding the determination of when excise taxes should be imposed on distributions made by a sponsoring organization from a donor advised fund and on the agreement of certain fund managers to the making of distributions.

DAFs were formally recognized in the Internal Revenue Code (the “Code”) in sections 4966 and 4967, which were added in 2006.  The proposed regulations address with greater specificity these sections’ definitions of a DAF, a donor, a donor-advisor, and a distribution.  While sponsoring organizations generally welcomed the increased clarity provided by these expanded definitions, the IRS received formal comments on the proposed regulations from more than 150 organizations.  The comments were clustered around several main areas of concern:

1.      The proposed regulations expand the definition of donor advised funds by potentially redefining certain types of field-of-interest funds and other collaborative funds as DAFs depending on the level and type of involvement by donors in committees supervising such funds.  Other concerns regarding the definition include the possibility that certain funds that grant scholarships or are only utilized to support a single identified organization may no longer fall into the category of funds that are considered exceptions from DAF categorization.

2.     Reasonable expenses incurred in the ordinary course of a sponsoring organization’s operations in carrying out charitable purposes could possibly be considered taxable distributions under the proposed regulations.

3.      Many sponsoring organizations have historically allowed donors to recommend that the donor’s own personal investment advisors be utilized to manage funds in a DAF.  The proposed regulations would reclassify these investment managers as “donor-advisors” resulting in the imposition of excise taxes under section 4958(c)(2) of the Code when fees are paid to such investment managers.

4.      The proposed regulations call for the changes to be made retroactively, which means that excise taxes might be inadvertently triggered without sufficient opportunity for correction.

In April 2024, a bipartisan group of members of the House Ways and Means Committee wrote to the IRS expressing concern that the proposed regulations could deter or discourage charitable donations, particularly to donor advised funds at community foundations.  The notice and comment period culminated in a two-day formal hearing in May 2024 featuring more than 30 speakers, at the conclusion of which the IRS promised to take into consideration the issues raised in the comments when drafting the final regulations.  It remains to be seen what effect, if any, the new administration may have on this process.