Charitable Donations and the ACE Act: Impacts to DAFs and Private Foundations

Charitable Donations and the ACE Act: Impacts to DAFs and Private Foundations

March 24, 2022

There may be changes coming in 2022 that will impact both donors and charities by how quickly gifts are received and when donors can take the tax deduction. The Accelerating Charitable Efforts Act (ACE Act) is a proposed legislation that if passed, will significantly impact those who give through Donor Advised Funds (DAFs) and Private Foundations (PF) as well as charities.

While the ACE Act's full legislative rules haven't been enacted as of March 2022, and, if passed, would be retroactive to any charitable donations made in 2022, even if made before the act becomes law. Here's what investors giving through DAFs and PFs need to know about the ACE Act to avoid IRS penalties starting in 2022:

DAFs are owned and controlled by sponsoring organizations that enable funds to remain inside the DAF and do not need to make a minimum distribution each year. Each time the donor contributes to the DAF, they receive a tax write-off. However, the charity does not always receive the benefit immediately, and not for years in some instances. DAFs have no timeline of when they must distribute funds unless it has $1 million or more, requiring them to distribute %5 of assets annually.

PFs often use DAFs to lower administrative costs, teach the next generation about philanthropy, or give anonymously. Under current law, distributing funds to a DAF from a PF counts towards the PF’s annual 5% distribution requirement.

The ACE Act aims to achieve faster fund flows to the nonprofit sector by restructuring the rules governing DAFs and PFs. The act seeks to resolve significant issues of charitable giving through DAFs and PFs:

  • Resolve the timeline mismatch between when the donor receives a tax deduction for DAF or PF funding versus when the charitable organization receives the grant.

  • Resolve the issue of donor control in perpetuity by eliminating the warehousing of funds for generations in private charitable vehicles.

  • The ACE Act would no longer allow distributions from DAFs to PFs to count towards the PFs 5% annual distribution requirement.

  • Grant monies received by a DAF from a PF must distribute from the DAF by the close of the first taxable year after receiving the grant. Failing to grant within the period will not count as a qualifying distribution.

  • A PF failing to fund its annual distribution requirement entirely could result in excise taxes of 30% of the undistributed amount and 100% of the undistributed amount.

Charitable donations to a DAF, as currently defined in IRS Code Section 4966(d)(2) but not falling into either new category of DAFs discussed below, would be treated as gifts to a "Non-Qualifying Donor Advised Fund." Contributions to such nonqualified DAFs could still offer a charitable deduction, but only under certain circumstances:

  • No deduction is allowed for a donor after the contribution of property other than cash until the Sponsoring Organization sells the property for cash.

  • No deduction is allowed to the donor for any year until the sponsoring organization distributes the donated cash (or the proceeds of a non-cash donation) to charity.

Under these requirements, the ACE Act creates permissible DAF distributions through which the donor retains advisory privileges over numerous years and receive an immediate tax deduction but with restrictions:

Qualified DAF #1- A Qualified Donor-Advised Fund (a "Qualified DAF") is a fund that requires the termination of the donor's advisory privileges after 14 years from the date of the gift. Gifts of "non-publicly traded assets" to Qualified DAFs would not be eligible for a charitable deduction until the Sponsoring Organization sells the donated assets.

Qualified DAF #2- A Qualified Community Foundation Donor-Advised Fund (a "Community Foundation") is organized and operated for serving the needs of a particular geographic community that is no larger than four states. Donors to Community Foundations may retain advisory privileges, but only if their total donated funds, aggregated across separate accounts, are less than $1 million (adjusted for inflation).

Donors may not retain advisory privileges if their DAF-held funds exceed $1 million. However, suppose the Community Foundation and donor agree that the Community Foundation will distribute at least 5% of the donated funds each year. In that case, these more significant donors can maintain and exercise advisory privileges.

Under current law, a grant-making PF (as opposed to an operating PF) must pay a 1.39% excise tax on its net investment income. The ACE Act encourages PFs to make more significant qualifying distributions by waiving the tax on net investment income for those distributing at least 7% of the value of the PF's assets within 25 years, as specified in its governing instrument, and that makes no distributions to "disqualified private foundations." A "disqualified private foundation" is any private foundation with a disqualified person who is also a disqualified person with the foundation making the distribution.

The ACE Act’s intention of accelerating the timeline from donation to receipt by the charity impacts  DAFs, PFs, and the receiving charity. While DAFs and PFs will continue to face regulatory changes, philanthropic efforts through a desire to do good for others will remain, requiring the guidance of financial and tax professionals to keep donors informed.