Donor Advised Funds Under Scrutiny: What You Need to Know

Donor advised funds (DAFs) are charitable giving vehicles that allow donors to make tax-deductible contributions to a sponsoring organization, such as a community foundation or a financial institution, and then recommend grants to their favorite charities over time. DAFs have grown in popularity in recent years, as they offer flexibility, convenience, and anonymity to donors, as well as lower administrative costs than private foundations.

According to the National Philanthropic Trust, there were more than 1.1 million DAF accounts in the United States in 2023, holding over $200 billion in assets. DAFs distributed more than $40 billion to charities in 2023, representing a payout rate of 20 percent.

One of the main reasons why donors choose DAFs is that they offer significant tax advantages. When donors contribute to a DAF, they can claim an immediate tax deduction for the full fair market value of their donation, regardless of whether they have decided which charities to support or not. This means that donors can reduce their taxable income in the year of their donation, while retaining the ability to recommend grants to charities in the future. Donors can also avoid capital gains tax on donations of appreciated assets, such as stocks, real estate, or art, which can further increase their tax savings. Additionally, donors can benefit from the growth of their DAF assets, as they are invested and managed by the sponsoring organization, tax-free.

Although there has been a reform bill stuck in the Senate since 2021, the Internal Revenue Service (IRS) has recently also announced that it will step up its oversight of DAFs, as part of its broader efforts to ensure compliance and better enforce tax laws. The IRS has issued new guidance and instructions for DAF sponsors and donors, such as clarifying the rules on donor acknowledgements, substantiating charitable deductions, reporting taxable distributions, and verifying 501(c)(3) status of recipient organization. The IRS has also indicated that it will conduct more audits and examinations of DAFs, especially those that involve complex transactions, large donations, or questionable practices. Some of the specific issues that the IRS will focus on are whether DAF:

• Sponsors are properly verifying the identity and charitable status of the grant recipients and exercising control and discretion over the grantmaking process.
• Sponsors are complying with all of the global payment regulations, including avoiding errors and fraud.
• Donors are receiving any benefits or privileges from the grant recipients that would reduce or eliminate their charitable deductions.
• Donors are engaging in any prohibited transactions with their DAFs, such as selling or exchanging property, borrowing or lending money, or paying compensation or fees.

Given the increased attention and scrutiny that DAFs are facing from the IRS, it is important for donors, nonprofits, and DAF sponsors to be aware of the rules and regulations that apply to their DAF activities and to maintain accurate and complete records and documentation.

DAFs are a popular and effective way of giving to charity, but they also face increasing scrutiny and regulation from the government and the public. Donors, nonprofits, and DAF sponsors need to be aware of the rules and risks that apply to their DAF activities, and to take steps to ensure that they are transparent, accountable, and compliant. They also need to consider how they can use their DAFs to support the most urgent and impactful causes in their communities, and to avoid accumulating funds that could be put to better use. By doing so, they can enhance the value and reputation of DAFs, and contribute to the social good.

Note: Please keep in mind that there are many nuances in the compliance of every one of these regulations and this is not meant to be comprehensive. If you think that these regulations apply to you it is important to reach out to expert attorneys and consultants and evaluate the experts, processes, and tools that can assist you in your company's compliance.