by Rick Sparkman
Pathfinders Wealth
Created by President George W. Bush in 2006, “donor-advised funds,” or DAFs, are a $230 billion industry that’s gone largely unnoticed by most Americans. The idea behind DAFs was to increase philanthropic giving by offering the wealthy better tax benefits to encourage them to support more charitable giving.
As stated on the IRS website, a donor-advised fund (DAF) is a “separately identified fund or account that is maintained and operated by a section 501c (3) organization, which is called a sponsoring organization. Each account is composed of contributions made by individual donors.Once the donor makes the contribution, the organization has legal control over it. However, the donor, or the donor’s retains advisory privileges with respect to the distribution of funds and the investment of assets in the account.”
Over the last few years, donor-advised funds have become one of the most popular ways to donate to charitable organizations. DAFs currently account for over 13 percent of individual charitable giving in the United States. In 2019, DAFs contributed around $27 billion to charities.
DAFs seem to be a good thing as far as charities are concerned, as well as a win for donors. DAFs allow individuals, families, or organizations to contribute to charities and gain immediate tax deductions. Donor-advised funds have several advantages over traditional forms of philanthropy because donors may recommend how and when funds are distributed to and used by the receiving organization. A donor can contribute multiple kinds of assets, including real estate, cash, or stocks. A DAF might even make an exceptional legacy planning tool by allowing a donor to involve their family in philanthropy and creating a tradition of charitable giving that could extend beyond their lifetime. Having a DAF may eliminate the need to create a private foundation, which can be extremely expensive and burdensome.
With DAFs, donors now have a simplified way to do their long-term philanthropic giving, and they also gain access to powerful tax advantages. For instance, when using a DAF, you could see a tax reduction of up to 60% for cash contributions. If you contribute appreciated securities, you could reduce those taxes by up to 30% of AGI. Donors may also be able to avoid capital gains taxes as well.
However, some drawbacks are causing concern for both charities and the IRS. One issue of concern is the amount of money that is flowing back to donors’ financial advisors after being given away. Normally, when a financial advisor’s clients decide to donate some of their assets to charity, it means they no longer have to pay their advisor to manage those assets.
However, when the charity is a DAF, an advisor may be retained and paid to manage that money. This arrangement often proves lucrative for advisors, who take in millions of dollars in fees. Thus, advisors have an incentive to encourage their clients to donate to a DAF versus donating directly to a public charity. Also, since an advisor gets a fee that is a percentage of the funds under management, they could advise their clients against actually distributing the money to charity. As long as funds remain in a DAF, outside advisors can charge fees for managing that money. It’s in a DAF advisor’s best interest to encourage donors to just sit on the money until they decide where they want it to go- which could take years, even a lifetime.
Some critics of DAFs point to a lack of transparency and accountability as a severe issue. Donors to a DAF, for instance, can recommend grants be issued from the DAF without disclosing their reasons or their identities. This lack of transparency may mean that philanthropic decisions won’t align with public interests. And, because DAFs handle the entire process, charities receiving the donations aren’t easily able to cultivate long-term relationships with donors.
According to the Biden Administration and charitable giving experts, the super-wealthy and their advisors could abuse DAFs. One advocacy group noted that currently, around 41 percent of all individual giving goes into DAFs used to “warehouse” wealth rather than to nonprofits serving critical needs. Critics are concerned that without new regulations, wealthy philanthropists will divert even more charity dollars from nonprofits. Concerns about this potential abuse led the IRS to hold two days of hearings regarding its proposals to clamp down on DAFs. One proposal involves broadening the definition of the kinds of accounts that qualify as DAFs and possibly applying a 20% tax to those accounts.
The IRS has also suggested expanding the definition of donor advisors to include “registered investment advisors” (RIAs) who help select DAF assets and perform ongoing management duties. The proposals would also penalize advisors and donors who abuse DAFs, imposing a 20% excise tax.
Not everyone is on board with these attempts to reform DAFs, however. Executives from multiple charities testifying at the hearings said the proposals would have a chilling effect on nonprofit donations, especially since charitable giving, in general, has declined significantly.
Financial services experts also criticized the inclusion of RIAs in the definition of donor advisors, thus subjecting them to enforcement. They noted that donor advisors are already banned from receiving direct compensation from donor-advised fund accounts.
Discover more:
https://www.irs.gov/charities-non-profits/charitable-organizations/donor-advised-funds#:
https://seansparkman.retirevo.com/download/sean-sparkman/AnnuityBKLET-seansparkman.pdf
