Donor-Advised Funds: Pros and Cons – Charity Lawyer Blog

Donor-advised funds (DAFs) have gained significant traction as a popular philanthropic vehicle, offering flexibility and efficiency for charitable giving. But how exactly do they work, and what are their pros and cons? Here’s everything you need to know about DAFs, including potential legislative changes that could impact them.

What Are Donor-Advised Funds?A donor-advised fund is a charitable giving account managed by a public charity. Here’s how it works:

1. Make a Contribution: Donors contribute assets—cash, securities, or other property—to a DAF sponsor. These contributions are irrevocable but qualify for an immediate tax deduction.
2. Sponsor Control: The sponsoring organization legally controls the assets, but donors retain advisory privileges, allowing them to recommend grants to their favorite charities or suggest investment strategies.
3. Grant Recommendations: Donors propose grants to qualified charities. While the sponsor is not obligated to honor these requests, most do.

Benefits of Donor-Advised Funds.

1. Tax Advantages:
   • Immediate tax deduction for contributions.
   • Avoidance of capital gains tax on appreciated assets.
   • Favorable deductibility limits compared to private foundations.
2. Anonymity: Unlike private foundations, DAFs allow donors to give anonymously, offering privacy and discretion.
3. Cost-Effective: DAFs are less expensive to set up and maintain than private foundations, with lower administrative burdens.
4. Flexible Giving:
   • Ideal for contributing non-cash assets like cryptocurrency or real estate.
   • Allows for both domestic and international grantmaking.
5. Family Involvement: DAFs can involve family members, fostering shared philanthropic goals across generations.

Drawbacks of Donor-Advised Funds.

1. Loss of Control: Once contributed, donors surrender legal ownership of the funds. Recommendations for grants and investments are advisory only.
2. Lack of Mandatory Payouts: Unlike private foundations, DAFs are not required to distribute a minimum percentage of assets annually, leading to criticism that funds can remain dormant.
3. Restrictions on Benefits: Grants cannot provide donors with tangible benefits, such as event tickets or auction items.
4. Fulfilling Pledges: Using DAFs to satisfy legally binding pledges can be complicated and requires careful structuring.

Proposed Legislative Changes. Recent proposals aim to increase oversight and encourage more active use of DAFs. Key potential changes include:

1. Mandatory Payouts: Legislation like the ACE Act proposes introducing minimum annual distribution requirements to ensure timely grantmaking.
2. Enhanced Transparency: Increased reporting requirements for DAF sponsors to provide greater clarity on how funds are used.
3. Restrictions on Transfers: Limiting the use of DAFs by private foundations to meet their 5% annual payout requirements.
4. Tax Treatment of Investment Advisors: Proposed rules may classify certain investment advisors as “disqualified persons,” subjecting them to excise taxes.
5. Tightened Foreign Grantmaking Rules: Stricter compliance requirements for grants made to non-U.S. charities.

Final Thoughts. Donor-advised funds offer a powerful and tax-efficient way to engage in philanthropy, but they come with certain limitations. As proposed regulations and legislative changes loom, understanding the nuances of DAFs is crucial for effective giving. Whether you’re considering establishing a DAF or already have one, staying informed will help you make the most of your philanthropic endeavors.

Ellis Carter is a nonprofit lawyer with Caritas Law Group, P.C. licensed to practice in Washington and Arizona. Ellis advises nonprofit and socially responsible businesses on federal tax and fundraising regulations nationwide. Ellis also advises donors concerning major gifts. To schedule