Donor-advised funds (DAFs) might not seem like the most captivating topic, but their growing prominence in philanthropy makes them critical to understand. As vehicles for charitable giving, DAFs are expanding rapidly, yet they operate with minimal oversight and can perpetuate inequities.
Understanding and addressing the complexities of DAFs is essential for those who value equity, social justice, and ensuring that charitable dollars reach the organizations that need them most.
What Are DAFs?
At their core, DAFs function as charitable savings accounts. Here’s a simple explanation.
Imagine a successful entrepreneur who decides to donate $1.5 million to charity but is uncertain about where to direct the funds. They place the money into a DAF held by an institution, such as a community foundation, which invests the funds, deducts a small administrative fee, and provides an immediate tax deduction for the donor.
The key feature—and potential problem—is that there is no legal requirement compelling donors to distribute these funds to charities within a specific timeframe. The money can sit indefinitely, growing through investments, while the donor enjoys their tax benefit.
This is a nice benefit for private foundations and other donors who don’t want to be rushed to make their distributions, but it also has a dark side.
Challenges and Inequities with DAFs
Several systemic issues make DAFs problematic.
No Timeline for Payouts.
Funds in DAFs can remain untouched for years, with only minimal amounts distributed, while the principal continues to grow.
Tax Break Without Immediate Charitable Impact.
Donors receive an immediate tax deduction when contributing to a DAF, but the funds may not reach nonprofits—or the communities they serve—for decades, if ever.
Potential for Exploitation by Private Foundations.
Private foundations, which are legally required to distribute at least 5% of their endowments annually, are permitted to use DAFs as a workaround. By transferring funds into DAFs, they meet their payout requirements without ensuring the money reaches working nonprofits. This is a nice benefit to avoid hasty grant-making decisions, but there are no limits to providing funds from being warehoused indefinitely.
Proposed Reforms – The Accelerate Charitable Efforts (ACE) Act
The Accelerate Charitable Efforts (ACE) Act seeks to address these challenges with modest reforms. Some key considerations with DAFs and the ACE Act include the ACE Act’s top three reforms:
Establish Payout Deadlines
Require DAFs to distribute funds within 15 years to qualify for immediate tax benefits.
Disallow DAF Parking
Prohibit private foundations from counting transfers to DAFs toward their 5% annual payout requirement.
Eliminate Certain Expenses from Payout Calculations.
Prevent foundations from including family member salaries or luxury expenses in their payout calculations.
These reforms aim to ensure that charitable funds serve their intended purpose more promptly and effectively.
Opposition to the ACE Act
Despite its modest nature, the ACE Act faces strong opposition from influential organizations in the philanthropic sector such as the Council on Foundations whereas state nonprofit associations tend to support the ACE Act.
Is There A Middle Ground
Experts may debate the merits of disallowing private foundation grants to DAFs or excluding compensation payments to insiders from the required distribution calculations. Both sides of these issues present valid arguments. However, the most critical aspect of the ACE Act is the establishment of payout deadlines.
A 15-year timeframe is both reasonable and practical, providing donors and foundations ample opportunity to make thoughtful and impactful distributions. Even if only the 15-year payout requirement were enacted, it would represent a significant step forward for the philanthropic sector.
Why This Matters
The ACE Act serves as a test for philanthropy. Can it adapt and regulate itself to address today’s challenges better, or will it uphold inequitable practices? Currently, more than $1 trillion sits in private foundations and $140 billion in DAFs, while nonprofits addressing urgent social, economic, and environmental issues struggle to stay afloat. During times of crisis, these funds should be mobilized to drive meaningful change—not hoarded indefinitely.
Ellis Carter is a nonprofit lawyer with Caritas Law Group, P.C., licensed to practice in Washington and Arizona. Ellis advises nonprofit and socially responsible businesses on federal tax and fundraising regulations nationwide. Ellis also advises donors concerning major gifts. To schedule a consultation with Ellis, call 602-456-0071 or email us through our contact form.