The IRS is considering toughening restrictions on donor-advised funds (DAFs), and it recently held a public hearing to discuss its plan, the Chronicle of Philanthropy reported.

According to the IRS, a DAF is "a separately identified fund or account that is maintained and operated by a section 501(c)(3) organization, which is called a sponsoring organization. Each account is composed of contributions made by individual donors. Once the donor makes the contribution, the organization has legal control over it. However, the donor, or the donor's representative, retains advisory privileges with respect to the distribution of funds and the investment of assets in the account."

DAF accounts allow donors to make a charitable contribution to a fund, receive an immediate tax deduction and then recommend grants from the fund over time. But the use of this method of setting aside money to spend on charitable causes is now being questioned. At issue is whether ultra-wealthy Americans may be abusing the immediate tax deductions they receive when they put money into DAFs, where it can remain indefinitely or until donors decide which nonprofits to support. 

The IRS has stated that it is "aware of a number of organizations that appeared to have abused the basic concepts underlying donor-advised funds. These organizations, promoted as donor-advised funds, appear to be established for the purpose of generating questionable charitable deductions, and providing impermissible economic benefits to donors and their families (including tax-sheltered investment income for the donors) and management fees for promoters."

Nonprofits have argued that DAFs provide both wealthy and average American donors with an easy way to give.

On May 6-7, the IRS held a public hearing to discuss its plan to regulate DAFs. The proposals include altering the definition of a donor-advised fund so that it applies to a broader swath of accounts; expanding the definition of donor advisers to include personal investment advisers who help manage assets in DAFs; and imposing new penalties on those who abuse the funds, the Chronicle reported. If approved, the IRS would impose a 20 percent excise tax on donations that provide significant benefit to the donor, among other changes.

Nearly $230 billion resides in DAFs, and there are now almost 2 million accounts, according to the National Philanthropic Trust, a leading sponsor of the funds. Nearly half of these accounts, which are easy to open, are valued at less than $50,000.

Applying new restrictions and a “compliance burden” on donors and DAF-sponsoring organizations could cause a further decline in charitable giving, warned Lisa Chmiola, who spoke on behalf of the Association of Fundraising Professionals at the IRS hearing, the Chronicle reported. Charitable giving dropped by 3.4 percent in 2022 to $499.3 billion. On the other hand, Fidelity Charitable’s DAF distributions went up more than 5 percent in 2023, to $11.8 billion.

“In our estimation, the proposed regulations, if implemented, would lead to fewer dollars swiftly reaching nonprofits we care about, and we respectfully ask the Department of Treasury to reconsider its approach,” said Andrea Sáenz, CEO of Chicago Community Trust, one of the nation’s largest community foundations, the Chronicle reported. 

An April 19 public letter signed by a bipartisan group of 33 House tax committee members called the IRS proposal “overly broad” and warned of the possible “chilling effect” that would take place if investment advisers also became donor advisers and if the definition of DAFs was broadened to include certain funds held by public charities, such as those that have advisory committees that include donors.

DAF critics were disappointed to learn that the IRS’s proposal doesn’t touch on whether donors should be required to pay out of their funds within a certain time frame to receive immediate tax breaks.

“That is a really big issue, the warehousing of wealth that people have gotten deductions today for and actually aren’t helping people for who knows how long into the future,” said Lloyd Hitoshi Mayer, a law professor at the University of Notre Dame, in an interview with the Chronicle.