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Proposed Federal Law Changes Requirements for Donor-Advised Funds and Private Foundations

Controversial bill aims to get funds to charitable beneficiaries quickly.

On June 9, 2021, U.S. Sens. Charles Grassley (R-Iowa) and Angus King (I-Maine) introduced the Accelerating Charitable Efforts (ACE) Act. If passed, the ACE Act would significantly change the requirements imposed on donor-advised funds (DAFs) and private foundations (PFs). Supporters of the legislation argue that the ACE Act will ensure that funds earmarked for charitable purposes reach charitable beneficiaries quickly. Opponents of the ACE Act assert that the modifications are unnecessary and will have a chilling effect on charitable giving.

DAF Provisions

Here’s a summary of the provisions involving DAFs.

Qualified DAF. The bill includes new definitions of a qualified DAF and a non-qualified DAF. A qualified DAF is required to distribute all funds to qualified charities within 15 years of contribution. A donor would receive an upfront charitable income tax deduction for gifts to a qualified DAF.

Non-Qualified DAF. If a donor contributes to a non-qualified DAF (one that doesn’t pay out all assets within 15 years), then the donor wouldn’t be permitted to claim an upfront charitable income tax deduction. For non-cash contributions, a donor couldn’t claim a charitable income tax deduction until the DAF sponsor sells the asset for cash and distributes the proceeds to a qualified charity. Furthermore, for any contribution, a donor wouldn’t be allowed to claim an income tax charitable deduction until the taxable year when the DAF administrator distributes the contribution to a qualified charity. Any income tax charitable deduction will be limited to the amount dispersed to a qualified charity. The DAF sponsor must distribute contributions within 50 years of the donation. If a DAF administrator fails to completely distribute a DAF within this period, the DAF administrator will incur an excise tax.

Qualified community DAF. The bill also establishes a new definition of a “qualified community donor-advised fund”—a DAF that a “qualified community foundation" (QCF) controls. A qualified community DAF wouldn’t be subject to the restrictions discussed above if the qualified community DAF meets at least one of the following requirements:

  1. No individual can have advisory privileges with respect to one or more DAFs sponsored by the community foundation with an aggregate value over $1 million; or
  2. According to a written agreement, the donor establishes the DAF requiring distributions of at least 5% of the value of the DAF’s assets each calendar year.

A QCF is a community foundation organized as an Internal Revenue Code Section 501(c)(3) charity serving a geographic area of not more than four states. In addition, a QCF must hold at least 25% of its assets outside of DAFs.

Income tax charitable deduction for gifts of non-publicly traded assets. No income tax charitable deduction for non-publicly traded assets donated to a qualified DAF or a qualified community DAF would be permitted until the asset is sold. Moreover, the income tax charitable deduction would be limited to the value of the proceeds.

DAF distributions and the public support test. For purposes of calculating a public charity’s support under IRC Sections 509(a)(2) and 170(b)(1)(A)(vi), when the sponsoring organization identifies the donor, the support is treated as being provided by such donor. However, if the donor isn’t identified, then the support is aggregated with all support provided by unidentified DAF donors as if a single person provided the support.

Excise tax on undistributed contributions. If distributions aren’t made in a timely manner after advisory privileges terminate, then an excise tax equal to 50% of the contribution, including any earnings thereon, would be assessed against the sponsoring organization.

PF Provisions

Here’s a summary of the provisions relating to PFs.

Administrative expenses paid to disqualified persons. The bill would disqualify administrative expenses paid to disqualified persons from being treated as qualifying distributions.

Distributions to DAFs. The bill wouldn’t allow a distribution to a DAF to be treated as part of a PF’s 5% annual payout unless the DAF makes a qualifying distribution of the contribution in the same year.

Exemption for tax on investment income. PFs making qualifying distributions of 7% or more of the PF’s assets would be exempt from the tax on investment income for that taxable year.

In addition, limited-duration PFs (that is, those having a duration of not more than 25 years and that don’t make distributions to other PFs (other than other limited-duration PFs) that share a disqualified person in common) would be exempt from the tax on net investment income. A recapture tax would apply to a PF that initially meets the requirements but then fails to fulfill the requirements later.

Support for the ACE Act 

Supporters of the bill assert that the legislation will result in more charitable dollars reaching charities in a reasonable period. The fact that DAFs currently hold $140 billion without any distribution requirement is cited as a compelling reason for the legislation.  According to the press release issued by Sens. Grassley and King, the proposed legislation will restore the connection between charitable tax benefits and benefits to charities. Further, the Initiative for Charitable Giving, which supports the bill, has identified two concerns that they perceive the legislation would address:

  1. the current mismatch between the timing of the income tax charitable deduction and the benefit provided to charities for DAFs and private non-operating foundations.
  2. the lack of disincentives to discourage perpetual DAFs and PFs.

Drawbacks of the ACE Act

Opponents of the legislation contend that “there is no data to indicate whether these measures would propel more charitable giving.” Critics point out that according to National Philanthropic Trust’s COVID grantmaking survey, DAFs increased grants to charities by nearly 30% in 2020. In general, DAFs tend to pay out around 20% each year without a mandated payout requirement. Fidelity Charitable, the country’s largest provider of DAFs who distributed $9.1 billion to charities in 2020, reports that for every $100 contributed to Fidelity Charitable, $76 has been granted to charities within five years and $89 within 10 years (2020 Fidelity Charitable Giving Report).  Thus, critics argue that the payout requirements that the bill would impose are unnecessary because charitable dollars are already flowing from DAFs at an increased rate.

Provisions that would affect PFs have also come under fire. For example, prohibiting PFs from counting gifts to DAFs as part of the PF’s 5% annual payout “ignores the many valid and useful ways that private foundations may use DAFs to further their charitable missions.” The uses include protecting donor privacy for grants made for controversial causes; making one-time grants for special causes, such as disaster relief, without committing to further gifts; and pooling resources with other donors without burdening the recipient charity with significant administrative oversight. Provisions prohibiting PFs employing family members from claiming salaries and expenses as administrative expenses have been criticized as unnecessarily punitive because “data show that family foundations are not more likely to claim high administrative expenses than staff-run foundations.”

Effective Date

Charitably inclined donors who wish to ensure their gifts will be subject to current law should consider making charitable gifts before the proposed enactment date of the bill, Jan. 1, 2022. Provisions relating to income tax charitable deductions would only apply to contributions made after the bill’s enactment.

This material has been distributed for informational purposes only and should not be considered as investment advice or a recommendation of any particular security, strategy or investment product. Information contained herein has been obtained from sources believed to be reliable, but not guaranteed. Bernstein does not provide tax, legal, or accounting advice. In considering this material, you should discuss your individual circumstances with professionals in those areas before making any decisions.

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