It’s common practice for public charities to offer benefits to substantial donors to thank them for their support. If the donor is a donor-advised fund, however, this arrangement becomes more complicated.
These donor-advised funds, or DAFs, have been part of charity for nearly a century and are a staple of community foundations. For individual or corporate donors, the charitable portion of the gift is reduced by the fair market value (FMV) of the benefits provided—back-stage passes, VIP ticket access, or memberships, for example.
With the increased use in DAFs, it’s important to understand the implications these benefits have on both the donee organization and the donor.
Prior to the Pension Protection Act of 2006 (PPA), the term donor-advised fund wasn’t defined in the code or regulations; however, it was understood to include arrangements in which some charitable organizations (including community foundations) established separate funds or accounts to receive contributions from donors.
The PPA enacted several provisions intended to improve the accountability of DAFs. It defined the terms donor-advised fund and sponsoring organization, and enacted or amended various excise taxes designed to penalize improper acts of DAFs as well as their sponsoring organizations, donors, and advisors.
The sponsoring organization and fund management are subject to excise taxes for:
- Distributions that don’t accomplish a charitable purpose
- Certain distributions where expenditure responsibility isn’t exercised
Donors, donor advisors, and related persons are also subject to excise taxes if they receive more than an incidental benefit from a donor-advised fund.
Donors and Investment Advisors
Internal Revenue Code (IRC) Section 4958 extended excess benefit transaction taxes to include donors to DAFs and the investment advisors associated with the sponsoring organization of the DAF.
The term donor-advised fund is reflective of this relationship: Donors have only advisory privileges to grant the assets in their DAF, and the charitable sponsor has the authority to approve or deny those recommendations.
Like most other charitable giving vehicles, there are restrictions on which organizations qualify as eligible recipients for DAF grants. Keep in mind that similar rules apply for private foundations. For example, donors can’t:
- Recommending that charitable grants be made to individuals
- Receiving any goods or services in exchange for their grant, such as a ticket to a gala
- Paying grants that go toward tuition to private schools or colleges for their own family members or certain individuals associated with businesses 35 percent controlled by the donor
A Recommended Distribution
Under IRC Section 4967, an excise tax is imposed when an advisor to a DAF recommends a distribution that results in “a more than incidental benefit,” whether directly or indirectly, to:
- A donor to the fund
- An advisor to the fund
- A member of the family of the donor or advisor to the fund
- A 35 percent controlled entity of a donor, advisor, or family member
The excise tax equals 125 percent of the benefit amount and is imposed on the advisor who recommended the distribution as well as the recipient of the benefit—they are jointly and severally liable for the tax. In addition, a 10 percent excise tax is imposed on a “fund manager” of the sponsoring organization that approves the distribution knowing it would confer a more than incidental benefit on the recipient, subject to a maximum tax of $10,000 for each such distribution.
In the case of DAFs receiving benefits for donations to public charities, consideration needs to be given to the “more than incidental benefit” component. While not directly defined, the interpretation of the rule is generally that the benefit, if less than 2 percent of the total contribution, is less than incidental. The most conservative approach is to recommend that DAFs don’t receive any benefit in exchange for their charitable contribution.
When membership benefits are provided in exchange for contributions, the area has more flexibility. This depends on the classification of membership fees as either contribution revenue or program service revenue. If membership fees are treated as contribution revenue, then the full portion of the donation is contribution revenue, including the membership portion. However, if membership fees are treated as program service revenue, then a benefit is provided.
When evaluating treatment of membership fees versus contribution revenue on Form 990, IRS instructions state:
“Membership dues that are not contributions because they compare reasonably with available benefits are reported on line 2, Program Service Revenue. Membership dues can consist of both contributions and payment for goods and services. In that case, the portion of the membership dues that is a payment for goods or services should be reported on line 2, Program Service Revenue. The portion that exceeds the FMV of the goods or services provided should be reported on line 1b.
The portion of membership dues attributable to certain membership benefits that are considered to be insubstantial (for example, low-cost articles, free or discounted admission to the organization's activities, discounts on purchases from the organization's gift shop, free or discounted parking) may be reported as contributions on line 1, rather than as payments for goods or services on line 2.”
We're Here to Help
As more companies begin utilizing DAFs for corporate giving and workplace giving campaigns, it’s important to consider:
- Including language for DAFs on donor solicitations that indicate the prohibition on benefits provided
- Educating the development team involved in soliciting contributions on the pros and cons that gifts from DAFs present to the donor
- Evaluating the treatment of membership fees on Form 990 as either contribution revenue or program service revenue
If you’d like to understand how utilizing a DAF will affect your organization, contact your Moss Adams professional.