Zelinsky on DAFs and Private Foundations

                    Andrew Carnegie

The Z Man makes an interesting argument in Tax Notes this week. I haven’t read the whole thing yet, but it sounds like he thinks DAFs are like Private Foundations and that like things should be taxed alike.  Horizontal equity is an irresistible seductress in tax law, especially in the academy. We pine for her, we flock to her like moths to flames. But I’m still not convinced.  It might just be a foolish consistency instead.  Or maybe I am just doubting the premise; maybe DAFs and private foundations are not alike.  One way that DAFs differ from private foundations is that they are not singular reservoirs of dynastic wealth. Are they? If they aren't, the difference may just be a matter of degree I'll admit. But somehow degrees seem to matter to me.   That’s just a thought.  I gotta read the article first.  Here is the Introduction:

The Donor Advised Fund Research Collaborative (DAFRC) recently published the results of its “comprehensive research initiative” about donor-advised funds. The DAFRC study is an important addition to the now-extensive literature on DAFs. Defenders of the DAF status quo will likely cite parts of the DAFRC study to bolster their opposition to any further regulation of DAFs.

In contrast, I suggest that important results of the DAFRC study confirm the advisability of establishing tax parity between DAFs and private foundations. In the interests of equity and efficiency, similar institutions should be taxed similarly. Because DAFs are functionally equivalent to private foundations, Congress should extend to DAFs three Internal Revenue Code provisions that today apply only to private foundations, that is, the code’s annual tax on private foundations’ investment incomes, the minimum distribution requirement for private foundations, and the limitation to tax basis of a donor’s charitable income tax deduction for most in-kind donations of property to a private foundation.

Section 4940 levies a modest (1.39 percent) tax on private foundations’ annual investment incomes. Section 4942 mandates that each private foundation must annually distribute to charity an amount equal to at least 5 percent of its assets. Section 170(e)(1)(B)(ii) provides that a donor to a private foundation of most in-kind property can deduct only the donor’s basis in that property, not the property’s full fair market value that the donor could deduct if the property was instead contributed to a DAF. As a matter of parity, Congress should extend those three code provisions to DAFs because DAFs are functionally equivalent to private foundations. The DAFRC study results bolster the case for such parity-based tax reform.

Two findings from the DAFRC study are the recent pronounced increase in new DAFs and the failure of many of these new, smaller DAFs to make charitable distributions of their resources. Extending section 4942’s minimum distribution rules to DAFs would inure these nondistributing DAFs and their advisers to paying out the funds they control — funds likely to grow in the future. Moreover, many sizable DAFs do not make timely distributions. As a matter of parity, section 4942’s minimum annual distribution requirement for private foundations should extend to functionally similar DAFs.

The principle of parity implies that Congress should apply section 4940’s annual tax on private foundations’ investment incomes to DAFs. Here again, the recent DAFRC study is instructive. The cumulative assets and incomes of DAFs are today substantial and will be even greater in the future. Section 4940 requires that, in light of private foundations’ ability to pay, they help to defray the costs of the social overhead that benefits those foundations as institutions situated in American society. DAFs have the same capacity as private foundations to help pay for the social overhead from which DAFs also benefit. Thus, Congress should apply to DAFs section 4940, which requires private foundations to pay federal tax of 1.39 percent of their investment incomes.

A third finding of the DAFRC study is that donors to sizable DAFs heavily donate noncash assets, such as appreciated securities, rather than contributing cash to those DAFs. These DAF donors can take income tax charitable deductions equal to the full FMV of the donated in-kind assets. In contrast, under section 170(e)(1)(B)(ii), taxpayers who contribute most forms of appreciated property to a private foundation can deduct only their basis, typically their much lower historic cost. Again, the imperative that similar entities should be treated similarly for tax purposes counsels that section 170(e)(1)(B)(ii) be applied to DAF donors. Thus, when contributors to private foundations are limited in their charitable income deductions to the basis of the properties they contribute, DAF donors’ deductions should be similarly limited.