Regulating donor advised funds.

• Author: Jones, Darryll K.

Donor advised funds provide a vehicle for philanthropy that allows the moderate philanthropist some of the same opportunities available to the wealthy philanthropist.

President Bush's tax reduction plan is not likely to take its final form, nor be adopted, for months. It seems almost unavoidable, though, that whatever plan emerges will be controversial in one aspect or another. Still, the final product is likely to contain many provisions of secondary and uncontroversial import, which are designed merely to protect or reinforce an already agreed upon underlying tax policy. One such agreed upon policy is that charitable, tax exempt wealth be controlled and managed exclusively to benefit the public.[1] Monies exempt from tax by virtue of their dedication to the public good cannot be used in a manner that conveys a private benefit.[2] In general, this policy is enforced with respect to public charities via a long-standing, though not entirely clear, set of rules geared toward improper profit taking[3] or excessive selectivity with respect to the persons benefited by the charity.[4] With respect to private foundations, more burdensome and expensive rules seek to ensure that tax exempt wealth is and remains exclusively for, and accountable to, the public.[5]

Donor advised funds, though, are rather like rectangular pegs that fit neatly into neither the square nor circular holes reserved for public charities or private foundations, respectively. On the one hand, donor advised funds offer the particular advantage--control--available from private foundations. On the other, they appear to operate in a manner most like public charities, since technically such funds are controlled by fiduciaries legally independent from the funds' primary benefactor. Because of this dual personality, the law seems ambivalent as to which regulatory form--public charity or private foundation--should apply to protect the public's wealth held by such funds. Last year, the Clinton administration offered an uncontroversial proposal seeking to clarify the status of donor advised funds and from that clarification impose rules designed to protect the public's vested interest in donor advised funds.[6] Owing to its lack of controversy, the fact that any subsequent proposal can be cast as a revenue raiser, and that fiduciaries of donor advised funds agree to the need for clarification and modest regulation, we might expect that the Bush administration will revisit the effort to regulate donor advised funds.

Anticipating the contours of such a proposal is not terribly difficult since the most interested parties--those that maintain such funds and the Treasury Department--have agreed to and narrowed the possible legislative and regulatory approaches down to two candidates.[7] The first would treat donor advised funds as public charities, while individual donors would be subject to regulation using the private foundation model.[8] In essence, the fund would avoid the costly and burdensome provisions related to private foundations, while the donor would nevertheless be treated with the same sort of suspicion applied to disqualified persons under I.R.C. [sections] 4941. The second choice would regulate donor advised funds and their donors entirely under the public charity model.[9] The fund would not be subject to special scrutiny, nor would the donor be forced to remain completely at arm's length from the fund. Curiously, it is the charitable community that is advocating the more hybrid approach under which donors are treated with suspicion, while the funds themselves need not comply with the other private foundation recordkeeping and reporting requirements.[10] As discussed below, this curious hybrid proposal perhaps proves something the charitable community has not previously acknowledged.

This article focuses on three aspects of the current effort to regulate donor advised funds and those who endow such funds. First, the article briefly comments on the degree of control a donor might exercise with regard to a donor advised fund without causing the fund to lose public charity status. Second, the article considers the proposed definition of donor abuse with regard to donor advised funds and the consequences that should follow upon a finding of such abuse. Finally, the article concludes by briefly questioning the motivations for the charitable community's efforts to regulate commercially sponsored donor advised funds using the private foundation model. The first two aspects upon which this article focuses are most relevant to practitioners who advise clients seeking a better method of charitable giving. The final aspect is more broadly related to encouraging philanthropy from all sectors of the economy, rather than reserving good works to a few well established outlets.

Though they have been around for quite some time, donor advised funds have recently been touted as a vehicle for the modern, and moderate, philanthropist.[11] In essence, a donor advised fund is just that. Donors are specifically recruited, or decide for their own reasons, to contribute to a fund from which grants are made to public charities. Donors are granted the explicit right to provide advice and recommendations not only as to the grant recipients, but also as to the amount and timing of the grant. And while a grant need not be made for some time after the donor actually contributes to the fund, the donor is entitled to a charitable contribution deduction immediately upon making the contribution. The fund's fiduciaries need not follow the donor's advice and recommendations, though as a...