Donor-advised funds have grown steadily over the past several years, in large part as a result of the benefits these funds bestow upon their donors, and the increased marketing of these funds by sponsoring organizations as a way of capturing donations from an expanding upper class. Some of their recent popularity, however, has been for the wrong reasons - a development that has not gone unnoticed by Congress.The Pension Protection Act of 2006 has tried to reign in some perceived abuses. As with most enforcement measures, however, the pendulum can now swing too far the other way and trap some well-meaning donors by surprise. The PPA has several dates that practitioners should watch in advising clients on donor-advised funds: Aug. 17, 2006; Feb. 13, 2007; and Aug. 17, 2007, as well as certain transition dates.


A donor-advised fund effectively allows a donor to give a large amount in a single year and receive a full charitable deduction for it at that time, while not having the contribution itself distributed for charitable purposes until future years. Future control by the donor, to determine both the charities receiving the grants and the management of the funds, needs to be nonbinding to be effective, but most sponsors are more than happy to attract funds by allowing such involvement. As an added perk, the donor's name may be associated with the future distributions.

Donor-advised funds typically set contribution minimums of $100,000, but some now accept donations as low as $10,000. Even lower minimums are expected as these funds become more mainstream in general fundraising efforts.

Donor-advised funds have been billed by many as an inexpensive way to have much of the benefit of a private foundation (or at least enough of the benefits) without the cost and without many of the restrictions.

A contribution to a donor-advised fund is deductible as an outright gift to charity. Cash contributions are deductible up to 50 percent of adjusted gross income; contribution of appreciated long-term-held publicly traded securities is deductible at full value up to 30 percent of AGI; and short-term-held securities are valued at the lower of cost or fair market value. Deductions for contributions exceeding these limits may be carried forward for up to five years.


As with outright contributions, donating appreciated securities is especially attractive because the donor recognizes no capital gain, while getting credit for the gain as part of their charitable deduction. It is also the most common asset used to fund donor-advised funds, no doubt tracking the run-up of the financial markets in recent years as the primary source of wealth responsible for donor-advised fund contributions.

This advantage also plays into the charitable giving strategy of donating now for future charitable use. It does so by allowing highly appreciated securities to be "liquidated" by the charity tax-free before they may decrease in value. At the same time, the donor can be credited in the arena of community opinion with being associated with a larger gift if the fund continues to appreciate. Finally, future appreciation in the hands of the fund is tax-free, enabling the contributed funds to grow more quickly.


In New Dynamics Foundation, April 24, 2006, the Federal Claims Court summed up the abuses that prompted congressional reaction in the PPA. The court rebuffed an organization's request for 501(c)(3) status, reasoning that it was merely a conduit through which donors could build up personal wealth tax-free and siphon off the accumulated wealth for personal expenditures.

The manual for the fund being scrutinized noted, for example, that "if the donor's child did volunteer work at a local hospital, the organization could pay the child a reasonable 'wage' for participating in the volunteer activity, while 'wages' for a charitable act would be taxable, grants and fellowships usually would not be."

The organization also touted being creative with "administrative expenses," such as paying the donor or a member of the donor's family a fee to attend a meeting or "research" an investment.


Cases such as New Dynamics Foundation were what sparked the recent reaction to donor-advised fund abuses by Congress. As mentioned, the PPA changes come referenced to three dates: Aug. 17, 2006; Feb. 13, 2007; and Aug. 17, 2007.

Aug. 17, 2006. The PPA introduces code provisions that have been made specifically applicable to donor-advised funds. Effective for tax years beginning after Aug. 17, 2006 (and therefore starting Jan. 1, 2007, for calendar-year taxpayers), the PPA specifically revised the code to define donor-advised funds, and then proceeded to specify penalties that will be applied within that definitional framework.

Code Sec. 4966(d)(2)(A) now defines a donor-advised fund as meeting three requirements:

1. The fund must be separately identified by reference to contributions of a donor or donors;

2. The fund must be owned and controlled by a sponsoring organization (a public charity or one operated through a regulated commercial sponsor); and,

3. A donor or a donor advisor appointed or designated by a donor must have, or reasonably expect to have, advisory privileges with respect to the distribution or investment of amounts held in the fund or account by reason of the donor's status as a donor.

Once the fund fits this definition, the law subjects "prohibited" activity to a host of new penalties effective for tax years beginning after Aug. 17, 2006, including:

* An excise tax equal to 125 percent of any benefit, either direct or incidental, flowing to a donor, donor advisor or related persons caused by advice to distribute given by that person. Knowing what constitutes an "incidental benefit" for purposes of applying the excess benefits tax, unfortunately, continues to be an issue unresolved by the PPA.

For example, the Joint Committee's illustration of incidental benefit as being a contribution to the Girl Scouts of America while the donor's daughter is a member of a local troop fails to address the many gray areas that remain to trap the unwary.

* An additional tax of 10 percent of the benefit (up to $10,000) is levied on any fund manager for making the distribution, knowing that the distribution would confer an improper benefit.

* A 20 percent tax is also imposed on the sponsoring organization for each taxable distribution.

Furthermore, for transactions occurring after July 25, 2006, donors, donor advisors and investment advisors to donor-advised funds (and those related to them) automatically are treated as disqualified persons with respect to the sponsoring organization under the excess benefit transaction rules of Sec. 4958. Certain transactions made under agreements prior to Aug. 17, 2006, are excepted.

Feb. 13, 2007. For contributions made after Feb. 13, 2007, the contribution to certain sponsoring organizations for maintenance in a donor-advised fund is no longer deductible. No deduction is allowed if the sponsoring organization is a veteran's organization, a fraternal society or a cemetery company, or if the supporting organization is a Type III supporting organization (other than one that is functionally integrated).

Also effective with respect to contributions made after Feb. 13, 2007, a donor must obtain a contemporaneous written acknowledgment from the sponsoring organization providing that the sponsoring organization has exclusive legal control over the assets contributed. Otherwise, no charitable deduction will be allowed.

Comment: Congress specifically foreclosed contributions to donor-advised funds of $100,000 direct rollovers of traditional IRA funds to charities by those 70-1/2 and older for 2006 and 2007. Distributions to these funds do not qualify.

Aug. 17, 2007. One final deadline may persuade qualified clients to consider setting up donor-advised funds quickly before Congress closes the gate on tax benefits even more tightly. The PPA requires the Treasury to submit before Aug. 17, 2007, a report on a detailed study of donor-advised funds with recommendations to the Senate Finance and Ways and Means Committees.

The study must cover a number of issues, including the appropriateness of a charitable deduction for assets of a sponsoring organization used in any way by the donor, the need for annual minimum distributions by funds and their sponsoring organizations, and the appropriate treatment of a gift as complete if certain rights (including advisory rights) are retained.


Donor-advised funds clearly remain a useful tool for charitably minded high-bracket individuals. However, the new and recharged excise taxes that have been made specifically applicable to donor-advised funds make planning mistakes considerably more expensive.

While the new rules likely will cut down on abusive arrangements, they also will make it more difficult for relatively innocent operational errors to go unchallenged.

George G. Jones, JD, LL.M, is managing editor, and Mark A. Luscombe, JD, LL.M, CPA, is principal analyst, at CCH Tax and Accounting, a WoltersKluwer business.

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