May 29, 2024

A Community Foundation Perspective on Donor Advised Fund Reform

by Bob Sorge

Madison Community Foundation’s mission is to engage Greater Madison in philanthropy to advance a more vibrant and equitable community. One way we do that is by sponsoring donor advised funds (DAFs), which give donors a vehicle through which they contribute assets (often at key moments in their lives, such as during the sale of a business), and then recommend distributions from those assets over time. Endowed DAFs can create a way for families to link arms across generations, creating permanent charitable legacies for the communities that have helped them thrive, and the causes that are important to them.

Originated by a Community Foundation, DAFs Boost Charitable Giving

While DAFs originated as giving opportunities provided by community foundations (the first DAF was created in 1931 by the New York Community Trust), more recently commercial investment companies have established affiliated charitable organizations to offer DAFs to their clients. This has resulted in a substantial increase in charitable giving through DAFs – and additional government interest in regulating their administration and taxation. On November 14, 2023, the Treasury Department and the IRS proposed new regulations about the taxation of DAF distributions.

As someone who has followed the evolving conversation around regulating DAFs for several years, I appreciate the Treasury Department’s and IRS’s desire to provide more clarity to organizations that administer DAFs (DAF Sponsors). However, as a community foundation leader, I am concerned that the proposed regulations are overly broad, difficult to apply and attempt to impose uniform requirements on fundamentally different types of organizations, resulting in a major negative impact on community foundations and the donors and advisors who work with them to enhance local philanthropy.

Proposed Legislation Overlooks the Differences Between DAF Sponsors

Unlike the Accelerating Charitable Efforts Act introduced to Congress in 2021, which MCF supported, the proposed regulations do not reflect the differences between community foundations and other DAF sponsors. To address this issue, I submitted written comments on the proposed regulations to the IRS and the Treasury Department on February 14, 2024, and supplemented those comments with testimony before a panel of Treasury Department and the IRS personnel on May 6. Several other community foundation leaders have also provided comments and testimony expressing their concern with these regulations.

Understanding the Key Issues

I want to share our perspective on some of the key issues with you:

1. The proposed regulations fail to appreciate the fundamental differences between community foundations and commercial gift funds.

While community foundations and commercial gift funds both administer DAFs, their similarities end there.

Community foundations are focused on improving the quality of life in a specific geographic area. They typically support a wide variety of causes through grants, and often provide other programming to benefit the community – such as professional development for nonprofit leaders; producing local research; convening nonprofits working on similar issues; and processing complex gifts for organizations that are too small to have the capacity for that work. The fees Madison Community Foundation receives for administering DAFs support this work and help us accomplish our mission to advance a more vibrant and equitable community.

Commercial gift funds, on the other hand, are typically affiliated with larger, for-profit investment managers. They don’t offer the same types of programs as community foundations, nor do they know the local nonprofits they make distributions to or the communities those nonprofits serve. Their value proposition is providing low-cost, fee-for-service to their clients. It’s simply a different business model.

As drafted, the proposed regulations impose several new compliance-related requirements on all DAF sponsors, regardless of their purpose or business model. Community foundations are not as large as commercial DAF sponsors, and they invest staff time in developing their communities. The new regulations would either divert staff resources from serving the needs of the community to comply with the regulations or require community foundations to raise fees to do both.

2. The proposed regulations fail to appreciate the multi-faceted relationships community foundations have with their donors.

The proposed regulations attempt to apply the same conflict-of-interest rules to different relationships donors may have with different funds. For example, a donor who sets up a DAF and is the sole contributor to that DAF has a far different level of influence over the distributions from that DAF than they do when they are one of thousands of donors to a fund and sit on a committee to review grant applications for that fund.

The proposed regulations lack the specificity necessary for effective implementation, and they fail to appreciate that community foundations are governed by boards comprised of volunteers – who also are donors that make gifts to these institutions to reflect philanthropic leadership. Their gifts to create a legacy for the future speak to the mission of a community foundation, and their generosity sets an example for the rest of the community. Strong conflict-of-interest policies that are already in place ensure the integrity of the process. There is no need for additional regulation.

3. The proposed regulations may actually encourage self-dealing for commercial gift funds, while limiting community foundations’ ability to provide donors with a variety of fund management options.

The proposed regulations classify an investment advisor managing both the personal assets of a donor and the assets of that donor’s DAF as a “donor-advisor,” unless that advisor is viewed as providing services to the sponsoring organization as a whole. Practically speaking, this encourages commercial gift funds to self-deal.

While commercial gift funds may assert that they are not controlled by their for-profit affiliates, their marketing materials and websites imply otherwise. Vanguard Charitable’s website boasts that Vanguard investments underlie the majority of its investment options – and that it “adheres” to Vanguard’s investment principles. And currently, both the staff and board at Schwab Charitable have extensive ties to Charles Schwab & Company, including the Board Chair who is also the President of the Charles Schwab Corporation. By using their affiliated for-profit entities to manage their assets, these organizations already are in compliance with this regulation.

In contrast, community foundations often use a variety of different investment advisors, which provides their fundholders with choices. However, under the proposed regulations, to ensure investment advisors serving fundholders at a particular community foundation are viewed as “… providing services to the sponsoring organization as a whole,” community foundations may have to actively market investment advisor services to broaden the number of fundholders who use a particular investment advisor and avoid paying penalties. This could put community foundations at odds with the best interests of fundholders by putting them in the position of advocating for a particular advisor to comply with the regulations. This would not serve the best interests of the community.

Community Foundations Hope Their Testimony Makes a Difference

We are hopeful that the comments MCF and our peers provided were persuasive in distinguishing the unique nonprofit nature and operating model of community foundations. Until these regulations are modified to even the playing field with commercial gift funds and honor the unique value community foundations have brought their communities for the last 100 years, we are not able to support them.