Monday, December 4, 2023
A few weeks ago, the Treasury released proposed regulations that apply to so-called “taxable distributions” of donor-advised funds (DAFs). (Previous Nonprofit Law Prof coverage here). For those of you who like Internal Revenue Code sections, these regulations interpret section 4966 of the Internal Revenue Code, which was enacted as a part of Congress’s 2006 attempt to explicitly regulate DAFs.
First, it’s important to mention that these regulations do not provide answers to what I think are the most pressing questions about DAFs. As I have mentioned before, for most of the nonprofitlaw-osphere, the most pressing question about DAFs is whether they should be required to distribute their assets in a timely way. Because Congress has not said anything about this issue (yet?), the Regulations do not address it. As I have also mentioned before, I’m most concerned about DAF “abuses,” especially those that involve distributions to a “conduit” charity. These regulations do not address that issue either, although it is on the IRS’s priority guidance plan. They also do not address the other important parts of the 2006 legislation: sections 4967 of the Code and the amendments to section 4958 of the Code, both of which are also on the priority guidance plan. Therefore, most of what I care about will (hopefully) be addressed in regulations that are still forthcoming.
What do these regulations cover? If you are interested in them generally, many law and accounting firms have published detailed online explanations, including this one from Morgan Lewis that was co-authored by the brilliant Chelsea Rubin, who happens to be a former student of mine (go Eagles!). Generally, “taxable distributions” are distributions from a DAF to any individual or organization that is not a public charity. Section 4966 requires (i) that these distributions be made for a charitable purpose, and (ii) that the DAF sponsoring organization use procedures (called “expenditure responsibility”) to make sure that the funds are used for those charitable purposes. Therefore, to take just one example, taxable distributions under 4966 include distributions used for “lobbying.” The regulations make it clear that DAFs cannot make distributions for the purpose of affecting legislation, and if they make distributions to (non-public charity) organizations for charitable purposes, they must use expenditure responsibility to make sure that none of the funds are used for lobbying.
There is one small part of these regulations that has implications for preventing the use of “conduit” charities. A distribution from a DAF to a public charity is not covered by these requirements, and, of course, once a distribution has been made to a public charity, it can engage in lobbying activity. To mitigate this possible loophole, the proposed regulations include an “special” anti-abuse rule in section 53.4966-5(a)(3). If a distribution is made to a public charity as an intermediary “pursuant to a plan” to avoid the rules, the rules ignore that intermediate step and treat it as “a single distribution.” In other words, if a donor tries to make a distribution from their DAF to a public charity as a step to make a distribution for a noncharitable purpose (like lobbying), then that distribution will be treated as if it was made directly from the DAF for the noncharitable purpose, triggering the penalty excise tax under section 4966. The intermediate distribution to the charity will be ignored. This “special rule” is extremely relevant in the context of section 4966 because it attempts to close a loophole that could permit DAF funds to be used for lobbying. But it also might have implications for closing the “conduit” charity loophole more generally in forthcoming regulations.
On the one hand, closing the conduit charity loophole is an important regulatory goal. On the other hand, this particular rule might be a hard rule to apply. It might be hard for a DAF sponsor trying to make rules to prevent it from happening, especially because so many public charities engage in lobbying activities. What exactly should the DAF sponsoring organization do to make sure that a distribution from a DAF to a public charity is not made “pursuant to a plan” to use the money for lobbying, when the recipient is engaged in lobbying activities? How should the DAF sponsor make sure that the donor does not “arrange for Charity X to use the funds to make [taxable] distributions.” Nor is it obvious what evidence the IRS would need to successfully prove that the donor has made a “plan” or “arranged” for the charity to use the funds for an impermissible purpose. DAF sponsors could reasonably want some guidance from the Treasury about what kind and how much diligence they should perform to avoid the risk of penalties.