How to Fix the Nation’s DAF System—a $250 Billion Question

This article concludes a three-part series: Saving Philanthropy: Creating Rules of the Road for Donor-Advised Funds. Co-produced by the Charity Reform Initiative of the Institute for Policy Studies and NPQ, this series examines how to facilitate giving while ensuring donor funds reach operating nonprofits in an efficient and effective manner.

As of the end of 2023, the National Philanthropic Trust (NPT) reported, over a quarter trillion dollars sat in donor-advised fund (DAF) sponsor accounts. Donors had received their tax deductions, but the money remained stuck in investment accounts.

The numbers tell the tale. NPT reported in The 2024 DAF Report that in 2023 donors added new contributions of $59.43 billion to their DAF accounts, grants disbursed totaled $54.77 billion, while $251.52 billion remained. That’s hundreds of billions of dollars that are destined for nonprofits, but haven’t arrived, even as the donors have already benefited from billions in tax deductions.

How does this occur? The problem of stalled contributions originated in a regrettable midcentury Internal Revenue Service (IRS) de facto policy that awarded immediate tax deductions for transfers to DAFs, but didn’t establish a payout requirement.

While the DAF sponsorship industry started small with community foundations, it exploded after the IRS approved public charity status for Fidelity Investments Charitable Gift Fund in 1991, Vanguard Charitable Endowment in 1997, and Schwab Charitable Fund (now DAFgiving360™) in 1999.

The three largest beneficiaries of charitable tax deductions are commercial DAF sponsors—far larger than the operating nonprofits United Way, Feeding America, or Salvation Army.

Ironically, today the three largest beneficiaries of charitable tax deductions are commercial DAF sponsors—far larger than the operating nonprofits United Way, Feeding America, or Salvation Army.

What can be done about this? Two solutions are outlined below. Option 1 is simple, but unfeasible. Option 2 is more complicated, but it may be the best way to keep the ease of the DAF system for donors, while ensuring that donor contributions actually make their way in a timely manner to the nonprofits that need them.

Option 1: No Tax Deduction Until the Money Arrives at an Operating Nonprofit

The simplest, most direct option would be to reverse the now established IRS policy by sunsetting the recognition of deductibility for contributions to DAF sponsor accounts. In other words, you could still have a DAF, but the tax deduction would only occur when the money is transferred from the DAF to an operating nonprofit.

This change in the timing of the deduction creates a built-in incentive to move funds into direct public service to actually qualify for the tax deduction.

This approach leaves most rules for DAF sponsors the same:

• Donors could still contribute as much as they want into donor advised funds. They would continue to receive a deduction from their individual adjusted gross income (assuming they itemize their deductions); the only change would be that they would receive this deduction only when the money is transferred to an operating nonprofit.
• DAF sponsors would continue to confirm that their transfers only go to organizations that fully qualify as charitable activities.
• DAF sponsors would continue to send required donor acknowledgment letters to DAF donors (above $200), but the letters would be sent when donors’ transfers go to qualifying nonprofits.
• Donors would continue to keep records for their taxes substantiating the eligibility of their contributions for a charitable tax deduction, and report these on their tax returns for the relevant year.

Such a change would certainly worry multiple DAF-adjacent parties, including the commercial DAF sponsors, some community foundations, and other institutions that have seen their revenues flourish through DAFs and DAF fees. Yet changing the timing of deductibility is the most logical response to what has become an awkward and counterproductive distortion in charitable giving.

Setting a time limit is the most obvious tool to deal with inactivity. DAFs would be required to pay out the entirety of any donations within five years.

The ideal solution would be to enact a sunset provision that ends immediate DAF deductibility going forward. This would, no doubt, create a mad rush to get in before the deadline and probably create a tax advisor field day. The end product would be a cleaner and more straightforward tax policy, with billions of dollars activated to make the world a better place.

So, why isn’t first option feasible? Politics is the art of the possible. In this case, a dispassionate assessment of the forces aligned for and against changing the timing of DAF contribution deductibility would put the odds overwhelmingly on the side of the status quo.

The arguments of historic precedent and bias toward settled law strengthen this view. The explosion of funds held in the DAF sponsor industry has fertilized a powerful collection of financial interests that benefit from DAF activity, despite not being the intended beneficiaries. This assemblage has grown to include commercial DAF sponsors, community foundations, wealth advisors, specialty attorneys and accountants, hopeful fundraisers, and even tech startups such as DAFpay and Daffy.org.

There is no question that support for the established treatment of DAFs is very strong among the businesses, trade associations, and professionals that profit from it. Accountants and attorneys would likely see changing tax treatment as an administrative nightmare. Community foundations (with a presence in almost every congressional district) would likely view this change as impinging on their strongest growth opportunity with donors. Commercial DAF sponsors would be prone to viewing such a policy shift as a threat to their charitable cash cow. Wealth advisors would see this tax treatment change as a threat to the asset management fees that they earn.

Regrettably, eliminating DAF overall deductibility and moving the point of deduction to when an operating nonprofit receives the money seems highly unlikely.

Option 2: A Workable Option to Rein in DAF Abuses

So, if shifting the point of deductibility is a pipe dream, what is possible? The second option is to address specific DAF policy abuse—either one by one or as a group.

From a “good government” standpoint, the US public has plenty of reasons to want someone to ensure that tax-exempt funds are efficiently deployed.

The following five reforms have been recommended to Congress in different versions by advocates, attorneys, and scholars over the years to address specific DAF issues. Some were included in the 2021 Accelerating Charitable Efforts Act (ACE Act), sponsored by Senators Angus King (I-ME) and Charles Grassley (R-IA) to speed up the distribution of charitable dollars held in DAFs and private foundations to working charities, and end practices delaying or diverting public benefit uses of these funds. Additional reform proposals included here are adapted from those advanced by the Charity Reform Initiative of the Institute for Policy Studies, and are supported by the Philanthropy Project that Jan Masaoka and I codirect.

1. Require a five-year payout for funds contributed to DAFs: Setting a time limit is the most obvious tool to deal with inactivity. DAFs would be required to pay out the entirety of any donations within five years after donations have gone into the fund, including any income earned on these original donations during that time. DAF sponsors would set up subaccounts under each fund for each calendar year to track the payout schedule of donations and income by year. This functionally ends perpetually endowed DAFs, where the income from the fund can be granted out to charity each year, but not the principal. Donors whose goal is perpetuity should have to abide by the more stringent set of rules established for private foundations.
2. Limit tax deductions for donations of complex assets to their sale value. As put forward in the Charity Reform Initiative’s policy proposals, this would “base the deductions for donations of complex, non-cash appreciated property such as artwork, real estate, and cryptocurrency on their actual sale value, rather than assessed value, and would delay that deduction until the year the property is sold. This would prevent donors from receiving charitable tax deductions based on overly inflated assessments of the property’s value” (2).
3. Disallow private foundation transfers to DAFs from counting as meeting the private foundation 5 percent payout requirement. This provision would instead require private foundations to report the beneficiaries, uses, and purposes of grants made from DAF accounts for which they have advisory privileges. DAFs should not serve as an end run around the private foundation rules of the 1969 Tax Reform Act, which required private foundations to pay out 5 percent of their assets each year and to specifically report the uses and beneficiaries of their grants.
4. Require DAF sponsors to report the purpose of transfers of funds to other DAF sponsoring organizations. As it happens, this accounted for $4.4 billion in DAF “contributions” in 2023. This curious and unexplained commerce between tax-exempt entities delivers no tax benefit, and risks decreasing public trust that these funds are used properly for charitable purposes.
5. Increase DAF transparency and reporting. Among nonprofit fundraisers, and even for state attorney general charity offices, the unapproachability and opacity of the $250 billion held in DAF accounts is well known. The Charity Reform Initiative’s policy proposals also address this issue, stating that, “donations to and from DAFs, as well as payout rates, should be publicly disclosed and reported on an account-by-account basis. To meet the IRS’s public support test, which ensures that charitable organizations are broadly supported, grants from donor-advised funds should also be attributed to the individual donor and not to the sponsoring organization. This could be done in such a way as to protect anonymous givers” (2).

What’s Next? How to Get DAF Reforms on the Books

Even getting the above five reforms will be no walk in the park. But, with appropriate public education, I believe these policy changes are achievable.

From a “good government” standpoint, the US public has plenty of reasons to want someone to ensure that tax-exempt funds are efficiently deployed. Addressing the DAF problem is of high importance for the same reason philanthropy is significant—these funds represent a rare and highly valuable resource, capable of incredible creativity and life-changing action when actually put to work

Even when new rules are in place, we will need a close watch by state attorneys general and the IRS. Both federal and state authorities have standing to confront improper uses of funds and unproductive charitable repositories—and to prioritize the timely and effective uses of these billions held in public trust.

Congress famously is known to move slowly. But it can be moved. Last year, a number of people in the field came together to launch the Philanthropy Project, advocating for public policies to make sure charitable funds benefit the public.

Increasingly, nonprofit and foundation leaders, boards, and volunteers understand what’s at stake. There is a long road to travel but the campaign has only just begun.