Proposed changes affect more than donor-advised funds, private foundations

| 8/19/2021
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Sens. Chuck Grassley and Angus King introduced a bipartisan bill, the Accelerating Charitable Efforts Act (ACE Act), which would make significant changes to the tax law governing donor-advised funds (DAFs) and private foundations. The legislation is motivated by two policy concerns – timing (matching the timing of a charitable deduction with charitable impact) and perpetuity (limiting the duration of DAFs and foundations to limit grant-making vehicles with perpetual life). While the bill has only been introduced at this stage, reactions are divided. Many philanthropic leaders have advocated for changes to correct perceived abuses, but others feel that the legislation might reduce total charitable funding.

Following are highlights of how the ACE Act affects DAFs, foundations, donors, and public charities.

DAFs. The ACE Act creates new DAF classes – qualified DAFs (QDAFs) and nonqualified DAFs (NQDAFs). QDAFs would allow the donor to deduct the value of a gift in the year that it’s given, but the donor must distribute the funds within 15 years. Amounts remaining in the QDAF at the end of the 15-year period would be subject to a 50% excise tax. NQDAFs (50-year DAFs) would not have an advisory period time limit, but failure to distribute all assets by the end of the first six months of the 50th year would result in an excise tax of 50%. If enacted, these changes would require increased oversight, administration, and reporting by sponsoring organizations.

Community foundations. The ACE Act defines qualified community foundation DAFs (QCFDAFs) as funds owned or controlled by a qualified community foundation. A foundation is a qualified community foundation if all of the following apply:

  • It is exempt under IRC Section 501(c)(3).
  • It is organized and operated for the purpose of understanding and serving the needs of a geographic community no larger than four states.
  • At least 25% of its assets are held outside of DAFs.

QCFDAFs must limit an individual’s advisory privileges to aggregate accounts with a value of less than $1 million or contractually obligate each DAF to distribute at least 5% of its assets annually.

Donors. The ACE Act would amend IRC Section 170 to delay a charitable deduction for certain donors until qualifying distributions are made by the sponsoring organization to a non-DAF charity. Additionally, the ACE Act would defer the deduction for all noncash DAF contributions of property (other than contributions of publicly traded assets to QDAFs and QCFDAFs) until the noncash property is sold by the sponsoring organization. Under the proposed amendments, the charitable deduction generally is limited to the amount of the qualifying distribution or net sales proceeds realized from the sale of noncash property, which could be significantly different from the donor’s expected deduction. An immediate charitable deduction would continue for contributions of cash and publicly traded assets to QDAFs and QCFDAFs.

Foundations. In addition to the specific rules applicable to community foundations, the ACE Act provides both incentives and penalties for foundations generally. Currently, foundations are assessed an annual excise tax of 1.39% on their net investment income. Under the ACE Act, this excise tax could be waived in two scenarios:

  1. In any year that a foundation’s charitable payout exceeds 7% (instead of 5%) of the fair market value of its noncharitable use assets
  2. If a foundation has a limited duration and agrees to distribute all assets to charitable organizations (other than disqualified foundations) within 25 years of its founding

The net investment income would be recaptured if the foundation fails to distribute assets within the applicable time period.

The ACE Act prohibits foundations from treating grants to DAFs as qualifying distributions, except for contributions made out of corpus within certain time periods. This change would resolve a perceived abuse of foundations using DAFs to hold funds required to be distributed under the 5% payout requirement or to avoid flipping a public charity grantee to private foundation status. Foundations making distributions to DAFs also will have additional reporting considerations and would be prohibited from treating administrative expenses paid to certain disqualified persons as qualifying distributions in calculating the 5% annual payout requirement.
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Public charities. The ACE Act modifies how public charities would treat contributions from sponsoring organizations in calculating their public support test. This change would remedy perceived abuses of contributions through DAFs to small or related organizations that might otherwise be moved into private foundation status. Currently, organizations treat contributions from a DAF as public support from the DAF’s supporting organization, a public charity. Under the ACE Act, contributions from a DAF would be treated as made by the original donor, subject to public support limitations if the original donor was not a public charity or government entity. If the original donor is not identifiable, the contribution would be aggregated with all unidentified amounts coming from all DAF supporting organizations as if from a single person rather than a public charity – thus subjecting the aggregate contributions to the public support limitations. This change could cause new or small organizations, or those with a limited number of donors, to fail the public support test and be classified as private foundations.

Looking ahead

While many doubt the ACE Act will pass in its entirety, the proposed legislation no doubt has many donors and charitable organizations considering steps to take in advance of legislative action. Prior to passage, the opposite of the act’s intended result might occur – accelerating and increasing gifts into DAFs. As the deduction for contributions to DAFs becomes effective only on enactment of the legislation, some donors might wish to act swiftly if they are considering charitable gifts to DAFs.

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