This article comes from the summer 2018 issue of the Nonprofit Quarterly, “Nonprofits as Engines of a More Equitable Economy.”
Without a doubt, the most noteworthy story affecting the charitable sector over the past twenty-five years has been the meteoric rise of donor-advised funds (DAFs). Within the blink of an eye, DAFs have grown from obscurity to ubiquity—and with the 2017 tax law1 making bunching the new word in charitable giving, the growth of DAFs is expected to continue unabated.
Consider the following:
- In 1992, the top ten fundraising charities were all well known to the public and included such familiar names as the American Red Cross, the American Cancer Society, and Catholic Charities USA. In 2017, none of the above charities were on the list, and six of the top ten were DAF sponsors and were unknown to most Americans (and sounding more like commercial financial institutions than traditional charities).2
- While contributions to charities as a whole have grown at a slow and steady pace, the rate of growth in DAF contributions has been astronomical. Since 2011, overall annual charitable giving has grown from $300 billion (in 2011) to $410 billion in 20173 (total growth of 36.6 percent).4 Over that same time period, annual contributions to Fidelity Charitable, the largest DAF sponsor, have grown from $1.7 billion in 20115 to $6.8 billion in 2017 (total growth of over 400 percent).6
- DAFs are not only being funded by individuals. Many private foundations make significant distributions to DAFs. Private foundations can use DAFs to satisfy their 5 percent distribution requirements while still retaining ongoing control over the distributed property. In addition, DAFs allow private foundations to meet their disclosure requirement (by reporting their distribution to the DAF sponsor) while maintaining secrecy about the ultimate recipient of their distribution.
Why have DAFs moved to such a dominant position in the charitable landscape? There are three main reasons for their extraordinary growth:
- DAFs enable donors to obtain current tax benefits of charitable giving while maintaining functional control over the investment and distribution of the donated property, without incurring the administrative expense and disclosure obligations imposed on private foundations.
- DAFs enable donors to obtain maximum tax benefits for their contributions by facilitating the donation of appreciated property. The donation of appreciated property provides a double tax benefit for donors, because it enables donors to both avoid capital gains taxes on donated property and offset their income tax liability based on the fair market value of the contributed property.7 These benefits are particularly valuable as applied to donations of complex assets—property other than publicly traded stock—because these assets only provide very limited tax benefits when contributed to private foundations.8
- DAF sponsors earn fees for the management of DAF funds. Ever since financial services companies have begun creating DAF sponsors, they have used their considerable marketing skills to fuel their growth. In addition, because individual financial advisors are also able to profit from managing DAF funds, their influence has assisted the growth of DAFs, as well. This increased public awareness of DAFs has fueled the growth of all DAF contributions, not just those associated with the financial services industry.
Three Steps to Ensure That DAFs Work for Everyone
DAF sponsors and their representatives take the position that DAFs have been an unmitigated good for the charitable sector—democratizing philanthropy by making it easy for small donors to create their own perpetual endowments, and opening new sources of charitable giving by facilitating donations of complex assets (referred to by some as “philanthropic fracking”). However, by focusing on the interests of donors, these arguments fail to recognize that two critical interests have been ignored in the existing regulatory approach to DAFs: (1) charities and the beneficiaries they serve, and (2) American taxpayers.
The following three rules would address these interests by ensuring that charities get the necessary funds to do their work, and that the government doesn’t provide tax benefits that are incommensurate with public benefit, thereby burdening American taxpayers.
Rule #1: Save Charities by Ensuring or Encouraging the Flow of Dollars from DAFs to Charities
Tax benefits for charitable giving were granted in order to increase the flow of dollars to organizations engaged in charitable work. DAFs undermine fulfillment of this purpose by allowing donors to get all of the tax benefits of charitable giving at the time that the donation is made to the DAF, without providing any mechanism (or even encouragement) to ensure that any of the tax-benefited dollars are ever made available for charitable use. Because current law does not require payouts from DAFs, donors can indefinitely defer charitable distributions from their DAF accounts, even across multiple generations. While some individuals distribute their DAF accounts entirely within a single year, others make no distributions at all. According to an IRS study, while some DAF sponsors have high overall distribution rates, nearly 22 percent of the DAF sponsors in 2012 made zero distributions.9 Even for those DAF