Donor Advised Funds – DAFs

Dr K C Gupta, YBB Personal Finance

Donor Advised Funds (DAFs; 1931- ) function like your own personal charitable foundation but without the expenses & headaches of actual foundations. Many wealthy people (including billionaires) are now using DAFs exclusively, or in addition to complex & expensive private foundations. Most DAFs offer limited menus of funds. Total annual expenses include the top-level expense ratio (ER) plus the ERs of the underlying funds. 

The DAF sponsors can be financial institutions such as Fidelity, Schwab, Vanguard; community foundations & even some corporations. To retail DAF users, these may work similarly, but they differ in their regulations.

Tax-deductible contributions can be made in cash or in-kind with highly appreciated securities (but there are income-related limits) – you save on capital gains tax & get itemized deduction for the full amount. There is tax-free growth within the DAFs. Any securities contributed in-kind are sold by the DAF ASAP. Donating MLPs to DAFs should be avoided due to additional tax complications.

Contributions are considered completed & irreversible gifts & are out of the estate of the “Owner”/ Grantor/ Donor (but clawbacks may apply to recent contributions). The IRA QCDs (qualified charitable distributions) cannot go into the DAFs.

Standard deductions are high now & many people don’t itemize. But you can bunch up intended contributions to DAFs & other itemizable deductions in certain tax years to file itemized Schedule A.

Anyone can contribute to your DAF, & you can contribute to another DAFs. You can also have multiple DAFs. The term “owner” is used loosely for DAFs & indicates limited ownership interests – those of recommending grants/ gifts/ donations, managing allocations within the DAF, designating successor “owners” & making more contributions.

Grants to IRS approved charities can be made at your own pace. “Owner” cannot receive any personal benefits in exchange for grants. Sponsors may follow a verification process if they are making a grant to a grantee for the first time. There may be prompts by sponsors if no grants have been made in a few years. Sponsors provide search services (GuideStar/ Candid, Charity Navigator, Giving Compass) for finding the IRS approved charities; you can also look for a recent public Form 990 filings by the nonprofit.

A DAF can make grants to another DAF. Sponsors also have Master/ general charitable funds & the DAFs can make grants to those; the DAFs merge into these master funds after there are no surviving “owners”. If you want the DAF to continue after you, name a chain of persons (relatives, close friends) as successors. 

The DAF operations are set up as separate 501c3 entities/ subsidiaries & are at arms-length from those of its sponsors. Note that 501c3 organizations are prohibited from political activities & contributions to them are tax deductible. But 501c4 organizations can engage in limited political activities & contributions to them are not tax-deductible. There are some organizations that run both 501c3 & 501c4 operations, so doublecheck on details if you are planning to make tax-deductible contributions. Wiki shows 29 types of 501c organizations, from 501c1 to 501c29.

The DAF critics say that many DAFs just hoard the money as the distribution requirements apply at DAF sponsors’ level, not at the individual DAF level (attempts to change this have failed). Many transactions may be among the DAFs to create the pretense of activity. Most sponsors have only a handful of mega-DAFs along with thousands of small DAFs, so that creates the appearance lot of retail activity. The DAFs can make anonymous donations. The sponsors aren’t required to disclose contributions, contributors & investment details. Some DAF assets include cryptos & US or foreign real assets.

There may be some long-term reforms down the road. Recently proposed changes would formalize the classifications of DAFs & donor-advisors, & some existing DAFs may have to operate with different regulatory frameworks. Stiff excise taxes of 20% for DAF sponsors & 5% for DAF managers may apply for abnormal uses of the DAFs. They will clarify how the DAF funds can or cannot be used. If some funds are used for personal or other taxable for-profit purposes or services, there will be excise taxes on DAF sponsors & DAF managers.

Now, some activities can develop under the DAF umbrella, but later can be converted to
taxable/ for-profit activities by paying taxes & properly compensating the parent DAF (note OpenAI news). Proposals will impose stiff excise taxes on the DAF sponsors & managers that will make this costly.

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