November 15, 2023

Donor-Advised Funds in the Crosshairs: Legislation Aims to Close Tax Code Loopholes

By Sara Smith, Manager, Tax & Business Services

Donor-Advised Funds in the Crosshairs: Legislation Aims to Close Tax Code Loopholes Year-End Tax Guide

Though nothing has yet become law in 2023, there continues to be much discussion of potential changes to donor-advised funds (DAFs) rules. Donor-advised funds are accounts held within a sponsoring 501(c)(3) organization. A donor-advisor contributes funds to their account within the sponsoring organization and retains the right to advise with respect to the sponsoring organization’s distribution of the donated funds (including appreciation) to other charitable organizations.

In recent years, legislation has been proposed regarding donor-advised funds (DAFs) to address perceived loopholes in the tax code, focusing on two main concerns: (1) the mismatch in timing between when a donor-advisor receives a tax deduction for a contribution to their DAF and when a charity receives those funds, and (2) limiting perceived endless donor control. The Accelerating Charitable Efforts (ACE) Act was introduced in 2021 to mitigate these concerns and remains the most comprehensive legislation under consideration focused on DAFs at this time.

The ACE Act contains several provisions to address the timing mismatch of cash and noncash contributions to DAFs. Under the Act, donor-advisors who contribute noncash property to their DAF would not be permitted a charitable contribution deduction until the sponsoring organization sells the property for cash. Further, for both cash and noncash contributions, no deduction would be allowed until the sponsoring organization distributes the contributed amount (or proceeds from a noncash donation) to a charitable organization—with the deduction being limited to the amount allocated to a charitable organization. These provisions aim to more closely connect the benefit of a charitable contribution deduction for a donor-advisor to when philanthropic organizations receive the funds—rather than when contributions are made to the DAF.

In addition, the ACE Act includes several provisions aimed at reducing perceived perpetual donor-advisor “control.” Current law does not require amounts contributed to a donor-advised fund to be disseminated to charitable organizations—the funds can remain undistributed, with the donor-advisor retaining advisory privileges in perpetuity. Under the proposed legislation, contributions made to a DAF would need to be distributed within a certain number of years or be subjected to a significant excise tax. The specific distribution period would range from 15 to 50 years, depending on the type of sponsoring organization. Failure to distribute contributions within the required timeframe would result in an excise tax on the sponsoring organization of 50% of the donations not distributed in a timely manner.

As donor-advised funds continue to grow in terms of number and scope in the charitable sector, scrutiny over perceived misuse will likely grow in tandem, triggering increasing calls for legislation to address the noted issues. It is uncertain whether the ACE Act will be adopted as law in its current form and, if so, when the various provisions will take effect. Also, the potential remains for new legislation to be introduced with expanded or new requirements. As any changes to the rules governing DAFs could significantly impact the charitable sector, it will remain important to closely monitor developments affecting DAF’s and the sponsoring organizations that offer them.

2023 Marcum Year-End Tax Guide