Wednesday, October 9, 2019
More than $110 billion that Americans have earmarked for charity are now housed in donor-advised funds. DAFs are a fundraising phenomenon that make it easy to set aside dollars for good causes and get significant tax benefits right away. But while the dollars are flooding into DAFs, too few dollars are coming out. That is because the legal framework governing these funds is out of sync with the way tax incentives are supposed to work. The reason for tax incentives is to get people to take an action deemed good for society, in this case, to make funds available so that charities can use them in support of their mission. But with donor-advised funds, the system is backwards: the federal government provides donors huge tax subsidies upfront, handing them out when the donor sets up a fund or augments it, but there is no incentive to actually give the money away. As legal scholars focused on public policy, we have long been concerned that the tax rules are not working as they should to get money to charities. When it comes to DAFs, we have advocated for the imposition of a payout term to ensure that DAF funds are distributed within a reasonable amount of time — say, a decade. While a payout is one solution, as we have been studying the issue and hearing objections from sponsors of donor-advised funds, we have realized there is an even better approach that could maximize contributions, help donors save on taxes, and avoid abuses that lose money for the Treasury. Our proposal essentially splits the tax benefit into two parts: Donors would get some financial benefits when they put money into the fund and receive additional benefits when they send money out of the fund to nonprofits they want to support.
The latest proposal for DAF reform comes from Roger Colinvaux and Ray Madoff, law professors at Catholic University of America and Boston College, respectively. Colinvaux and Madoff are thoughtful and accomplished scholars of nonprofit law whose ideas attract wide attention — and rightly so. Their suggested reform — under the headline “A Donor-Advised Fund Proposal That Would Work for Everyone” — would deny DAF donors a charitable-contribution deduction until money is distributed from their accounts to an active charity. At the time of distribution, under Colinvaux and Madoff’s proposal, donors would be able to deduct the amount paid out to charity (which may be more than donors put in if their DAF investments appreciated in the interim). This, the authors argue, would encourage DAF donors to put their charitable funds to use quickly rather than allowing dollars to languish in DAFs for lengthy periods. Colinvaux and Madoff’s idea is, in some respects, a “light touch” approach to DAF reform. Contrast their proposal with alternatives that would require DAFs to distribute funds within a short timeframe (e.g., five years) or to pay out a certain fraction of their assets annually (e.g., 7 percent). Colinvaux and Madoff would not require anyone to do anything; they would instead delay (but not deny) tax benefits. Theirs is a nudge rather than a hammer. Nonetheless, the Colinvaux-Madoff proposal would have wide-ranging ramifications for DAFs and their donors. It would stymie taxpayers who seek to use DAFs to spread philanthropic activity across the life cycle. It would dramatically reduce the tax benefits of DAFs for middle-income donors. And it raises the potential for unintended and unwanted consequences.
Darryll K. Jones