The Economist Weighs In on Donor-Advised Funds: A Philanthropic Black Box?

March 23, 2017; Economist

Last week, The Economist weighed in on the donor-advised funds debate with an article detailing many of those misuses of the vehicle that have been documented to date.

The story starts with the giving profile of one donor who used his fund to make donations—to a hospital at which he recovered from an accident, to a swimming pool at his children’s school—and for some more arm’s-length purposes, much as a checkbook donor would do. While the donor’s money was parked at the fund, however, he received a tax deduction on the whole amount, which he can now give away at will.

There’s no legal problem in terms of this donor’s giving, although some self-interest is evident, and this is the way many people of reasonable means give. Some money goes to causes close to them and that will benefit them somehow, and some gets spent more altruistically. But not every donor has as benign a profile, and by design, donor-advised funds are hard to see into, which makes some donor practices hard to track directly. The veils provided by the donor-advised fund, given that the money has already been counted as a tax-deductible donation, allow for a certain lack of public accountability, which many feel is inappropriate and leads to abuse.

Those veils are evident in NPQ’s recent coverage of issues raised for community foundations that facilitated DAF and other special fund grants that caused public furors and drew mea culpas from the foundations once they were revealed. The latest was a grant given through the Community Foundation of the Central Savannah River Area to a white nationalist group headed by Richard Spencer.

For some community foundations, donor-advised funds constitute a large portion (if not the majority) of their asset pool. What’s most often observed in practice is that the grantmaking is left to the individual donor or designee, who gets only the most superficial of accountability checks pre-grant. Thus, the donors have relinquished ownership but not control while still receiving a tax break, much as if they established a private foundation, but with far less transparency.

But the Economist’s research focused on the top three fund providers, which together hold more than $24 billion combined. All three are affiliated with for-profit money managers (Fidelity, Schwab, Vanguard).

Historically, the legal tool of the donor-advised fund was used mostly by local community foundations. About 25 years ago, an investment management company created its own charitable fund. Since then, the Fidelity Charitable Gift fund has catapulted to the top of the list with $2 billion in assets in 80,000 DAFs managed on behalf of 132,000 fund investors. Of course, the for-profit side of the house manages the funds and collects fees. But it’s not actually clear what it spends for what. One reason advanced to support DAFs is that it allows people with windfall income—for example, the sale of a business—to avoid taxes by “donating” it to a DAF which then allows an immediate tax deduction to offset the windfall income and allows them to parcel out gifts to charities at some undetermined point in the future.

Data on how the funds operate is scarce, as is information for charities seeking support. This leaves grant-seekers dealing, as ever, with the individual donor that advises any particular fund. Few reporting requirements exist in law. As a result, it’s hard to know how much or little good some of the funds do, or how much or little any individual fund has expended, since payout rates are reported in aggregate.

There’s evidence that some might be used to game the system by obscuring behind-the-scenes machinations. For example, the Economist says that some DAFs are “used to funnel money to political campaigns and lobby groups,” further obscuring donors from public view if the donor does not reveal his or her identity. DAFs may also allow private foundations to sidestep rules requiring them to make a certain proportion of their assets in annual donations to charity:

Some funds are used not to give but to game: For instance, to sidestep the 5%-minimum rule on foundation payouts. Donors can shift money from their foundation to a DAF as a way of meeting this threshold without actually giving anything to charity. The Economist examined grants from a random sample of about 4,000 foundations. Some 40 of them routed cash to the biggest DAF providers, amounting to about 1% of the value of all their contributions. This may seem like a negligible sum, but 11 of the 40 gave over 90% of the money they paid out to DAF suppliers. This is not illegal, but it does appear to flout the spirit of the tax code.

Even though Fidelity’s fund is technically a nonprofit, it doesn’t reveal what it spends its overhead on or the salary of its CEO or its top managers, something considered a best practice and typically a federal requirement for credible nonprofits. The most recent 990 filing for the nonprofit lists costs of raising the money as zero, as is the entire category of salaries and other compensation. The DAF skirts IRS compensation reporting requirements by using a loophole technique called a “master services agreement” (MSA). The expense line item (Line 11a, page 10) in its most recent 990 for MSA is $47,525,919.

Both Republicans and Democrats say it’s time to take another look at tax law. The last time Congress took a hard look at charity and foundations was in the late 1960s. Much of what we take for granted in the way foundations and the planned giving industry operate was confirmed or codified in this period. As Congress again looks at tax law in regard to donor-advised funds, what should they look at?

• Is it time to require money to be used much sooner? After all, the point of a tax deduction today is to encourage money to be used to help society today—not many years from now. Doing good is doing good, and if it’s not actively doing good now or very soon, why should taxpayers subsidize a few with tax breaks up to 50 percent of their income?

• What should the payout rate be? Many have called for higher payout requirements. Foundations are required to pay out five percent, though they can count administrative expense, including offices and salaries, as part of their required payout amounts. Are the payout rate minimums much too low?
• What should the funds be required to disclose? If taxpayers are providing a subsidy to the donor, aren’t taxpayers due basic information about what happens with the money? Transparency should be a minimum threshold.
• Is the DAF mostly a tax shelter? Is it a way for wealth managers to hold on to money and earn ongoing, additional fees? The national rate of philanthropic giving has been relatively flat for years. Does the rapid growth of donor advised funds actually reduce the money available to working charities to accomplish good work today?
• What is the real value of the funds to a typical donor? In practice, the funds are not for “everyday” donors. The reality is that the average fund size in the funds is $255,596. It’s more than double that for community foundations, $580,326.
• Do DAFs actually increase giving? What if they don’t? Many holders of DAFs give generously to good causes. However, “concerns will linger that DAFs allow the rich to reap financial benefits from financing pet causes they might well have backed anyway—and that more advantages accrue to donors than to the causes they are supposed to be helping. At present, there is scant evidence to suggest they fuel an overall rise in giving. Many philanthropists sing DAFs’ praises. But that does not prove their worth to society as a whole.” If they don’t really increase giving for current work, why should they be subsidized with tax benefits?

Questions like these openly challenge the concept of “for good, for ever” that appeals to many foundations, donor-advised funds, and their donors and managers. A donor’s desire to leave a perpetual giving legacy while receiving immediate tax benefit for doing so is running up against the belief that billions of charitable dollars are being warehoused rather than used to address current needs.

The Economist has joined an active field of skeptics with this article, which suggests regulators and lawmakers will examine the field more closely in the future. The funds, whether in money management firms or foundations or elsewhere, may wish to be well prepared.—Kevin Johnson