Countering Donor-Dominated Philanthropy

Countering Donor Dominated Philanthropy

The Law Center submitted a public comment to the IRS last week about new federal regulations being proposed about Donor Advised Funds or DAFs. We intervened with the hopes that our perspective as a movement support organization would be a helpful counterbalance to the numerous comments from the wealth defense industry—including foundation interest groups and fund managers. Our overall message was: these funds belong to the community, not to donors. We see this intervention as harm reduction in a current context of unlimited donor control in the nonprofit sector. While our suggested changes alone would not transform philanthropy into grassroots-driven funding flows oriented towards movement solidarity, not charity, we would see it as a step in the right direction—curbing the commercial DAF industry.

[Excerpted Summary of Our Public Comment Letter:]

The Sustainable Economies Law Center cultivates a new legal landscape that supports community resilience and grassroots economic empowerment. Since 2009, we have partnered with nearly 100 local grassroots groups and offered donation-based legal advice to over 3,000 values-driven organizations. After more than a decade of advising community organizations, we realized we needed to help our partners receive more funding and on better terms from philanthropy, in order for them to address the urgent crises they were facing. In that vein, we create free legal resources and hold workshops for funders looking to boldly, ethically, and creatively redistribute their wealth.

We base these comments on our wide range of experience working with nonprofits and donors. We conclude that the current regulations do not account for a major weakness in the definition of a donor advised fund (DAF): While DAFs are supposed to be “owned and controlled by a sponsoring organization,” the regulations fail to address how little control sponsoring organizations have over DAF funds in practice. With this sleight of hand, donors treat the funds in their DAF as they would treat funds in a private foundation. Systemically, this weakness allows donors to enjoy the well-known tax and disclosure benefits of DAFs compared to private foundations, while retaining as much control as they would have over a private foundation.

The Rise of DAFs

The popularity of donor advised funds has grown dramatically in the last two decades. In 2006, DAFs had an estimated total value of $31 billion. By 2022, that number grew to $229 billion, meaning a seven-fold increase.

While DAFs became more popular, private foundations became less so. From 2006 to 2022, the value of private foundations assets increased from $646 billion to $1,158 billion [editor’s note: holy cow], representing less than a two-fold increase. Not only have the relative size of DAF funds grown, but donors are also contributing more to DAFs in absolute terms than they are contributing to private foundations. Donors gave nearly $86 billion to DAFs in 2022, while giving about half that amount, $45 billion, to private foundations.

Donors looking to make large gifts eligible for a charitable deduction often choose between giving to public charities and establishing a private foundation. Donors receive the following benefits if they choose to give to a DAF rather than a private foundation:

- More favorable tax deductions

- No tax on investment growth

- No mandate to payout funds annually

- No transparency requirement to disclose where you are giving

The animating logic of this legal framework is that donors may access the tax and disclosure benefits of opening a DAF account rather than a private foundation so long as the donor gives up the control that a private foundation would otherwise afford. However, the notion that the funds in a DAF are “owned and controlled by a sponsoring organization” is currently a mere legal fiction.

The Reality of Donor-Controlled DAFs

In the economic reality of the DAF industry, donors have almost exclusive control over: (a) how the funds are invested, (b) when the funds are disbursed, (c) how much of the funds are disbursed, and (d) which charities the funds go to.

This contradiction between the regulatory scheme and reality is clear even from how the largest DAF sponsoring organizations present themselves. For example, Vanguard Charitable advertises: “Support charities you believe in: Find a charity you wish to support and recommend a grant… Supporting your favorite charities is easy.” This language reflects the business model of the commercial DAF industry, which depends on donors believing that they ultimately have control over DAFs.

The problem is not just one of advertising and donor expectations; rather, it concerns the real power dynamics at play. Donors exercise all meaningful control over DAFs and sponsoring organizations only nominally “control” the funds.

Donors to many DAFs are assured an arrangement analogous to having checkbook control over a private foundation: an entity that they can manage the assets of, invest as they choose, and issue grants to the charities of their choice in the amount and timing of their liking—all without the disfavored tax treatment, payout requirements, or disclosure requirements that would come with a private foundation.

However, the logic of this legal framework suggests that if donors to DAFs do control DAF funds, then they should be treated just like donors to private foundations—namely, they should be subject to all rules that accompany being a private foundation. Donors should not be allowed to use DAFs to effectively create private foundations embedded within sponsoring organizations that are free of private foundation regulations.

The charitable impact of this discrepancy is significant, even just measured by the absence of a payout requirement for DAFs. A 2022 analysis of 57 major DAF sponsors by the California Department of Justice found that “32 percent of DAFs in commercial sponsors and 42 percent of DAFs in community foundations paid out less than 5 percent.”

Recommendations Regarding Proposed Regulations

Our recommendation is for the IRS to outline criteria on whether sponsoring organizations are exercising meaningful ownership and control over DAF accounts. If ownership and control are not being exercised in a particular DAF arrangement, then the fund should no longer be treated like a DAF. Instead, it should be subject to all of the rules that apply to private foundations—including minimum expenditure requirements, less generous tax deductions, annual disclosure of the identity of donors and donor-advisors, and disclosure of grantees. It should be established that simply holding legal title to DAF funds and providing a ministerial compliance check on grant recipients is not enough to constitute a DAF. For that reason, we suspect that the vast majority of existing DAFs, especially those held by commercial sponsors, would fall into this category without reforms to their governance and operational structures.

The IRS could create a safe harbor for sponsoring organizations looking to easily meet the test of exercising control and ownership over their DAFs. We suggest that if a sponsoring organization proactively and without donor advice disburses 5% of all contributions to a DAF and 5% of a DAF account per year, then it is exercising meaningful ownership and control. The rationale for this construction is that, by relinquishing their assets to a sponsoring organization, a donor actually has to give up some meaningful control over the assets—even if just 5% of the assets. And since they are giving their funds for a public charity to control, donors should choose a charity that they trust to disburse 5% of their funds in a values-aligned way.

Some sponsoring organizations are already piloting DAFs that follow this form. For example, a template DAF agreement released by the Richmond Community Foundation allocates 5% of each DAF contribution to its Community Impact Fund. In an even more unique example, Seeding Justice offers a donor advised fund in which donors can recommend grants for only 40% of contributed funds; meanwhile 50% of the DAF’s giving is directed by a grassroots grantmaking committee, and 10% returns to Seeding Justice.

Additionally, the IRS may want to provide more guardrails to ensure that donors’ advice remains “nonbinding.” For example, if the sponsoring organization is not suggesting any disbursements itself or screening donors’ recommendations in any meaningful (non-compliance oriented) way, then the threshold for a donor’s advisory privileges will have been exceeded. If a donor is found to have binding control—and not just nonbinding advisory privileges—then the fund will again be subject to the payout requirements, tax treatment, and disclosure requirements of a private foundation.

We do also acknowledge and applaud that the proposed regulations define several circumstances in which the arrangement ceases to be a DAF altogether, such as when grantmaking decisions are made by sponsor-appointed advisory committees.

We urge the IRS to take decisive action to ensure the fair and equitable regulation of DAFs as intended by Congress.

Showing 1 reaction

  • Mohit Mookim
    published this page in Blog 2024-02-21 11:58:20 -0800

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