Proposed Federal Tax Law Changes Affecting Private Foundations & Donor-Advised Funds
The IRS has long scrutinized private foundations (PF) and donor-advised funds (DAF). The last major piece of legislation to reform the charitable sector was in 2006 with the Pension Protection Act (PPA). On June 9, 2021, Senators Angus King (I-ME) and Chuck Grassley (R-IA) introduced the Accelerating Charitable Efforts Act (ACE Act), a bill that has a similar goal as the PPA, which codified the current rules governing DAFs. A joint press release by the senators stated that the ACE Act’s purpose is to reform PFs and ensure that DAFs make resources available to “working charities” in a “reasonable period of time.”
Many of the provisions highlighted in the ACE Act were derived from the November 2020 IRS Tax Advisory Council’s recommendations, as well as a new coalition of philanthropists and foundations.
The ACE Act introduces a complex set of incentives and penalties to encourage philanthropic giving to reach “working charities” faster. To achieve this goal, the ACE Act would modify the way net investment income tax is calculated by ultimately eliminating the current 1.39 percent (for tax years starting January 1, 2020) to zero percent if the PF distributes in excess of 7 percent of the net value of noncharitable use assets. The ACE Act also would divide DAFs into various categories, including qualified and nonqualified DAFs. The major provisions of the ACE Act are outlined below.
- Administrative Expenses – PFs would no longer be entitled to count certain administrative expenses paid to disqualified persons (other than nonfamily foundation managers) toward meeting the minimum distribution requirement. For example, the ACE Act will prevent a foundation from including compensation paid to a substantial contributor or such person’s family members as qualifying distributions.
- Distributions to DAFs – PFs wouldn’t be permitted to include distributions to DAFs as qualifying distributions for purposes of meeting their minimum distribution requirement. Distributions to DAFs would be required to be reported on the PF’s annual Form 990-PF.
- Information Reporting: Significant Qualifying Distributions – Under current law, PFs must distribute at least 5 percent of the net value of their noncharitable use assets per year. In addition, they’re subject to a 1.39 percent excise tax on their net assets. The ACE Act would eliminate the 1.39 percent excise tax applicable to a PF in any year in which the foundation distributes at least 7 percent of its net value noncharitable use assets.
- Limited Duration Foundation – The ACE Act would eliminate the 1.39 percent excise tax on any “limited duration foundation” (LDF) defined as a foundation with a duration of less than 25 years contained in its governing documents. An LDF may not make any distributions to a “disqualified private foundation,” defined as any PF that has disqualified persons in common with the LDF. If an LDF fails to qualify as such in any year, it will be subject to a recapture tax equal to any tax benefits the LDF previously received.
New Donor-Advised Fund Categories
- Qualified DAFs: Time-Limited National DAFs – The ACE Act defines “qualified DAFs” (QDAF) as DAFs (including nongeographically limited DAFs) that impose a 15-year limitation on advisory privileges imposed upon any donor commencing from the contribution date. Contributions to QDAFs must designate a charitable recipient to receive the remaining assets undistributed at the end of the 15-year time limit. This requirement is similar to charitable remainder trust requirements. “Nonqualified DAFs” (NQDAF) are DAFs that have no time limitation. If a QDAF fails to pay out within 15 years, then the sponsoring organization must pay a penalty tax of 50 percent of the amount that hasn’t been distributed.
- Qualified Community Foundations: Geographically Limited Community Foundations – The ACE Act defines a “qualified community foundation” (QCF) as a 501(c)(3) organization whose purpose is to understand and serve the needs of a geographic community that’s no larger than four states and that has at least 25 percent of its assets held outside of DAFs.
- Size-Limited QCFDAFs – The ACE Act defines “qualified community foundation DAFs” (QCFDAF) as DAFs sponsored by a QCF that limit donor advisory privileges to DAFs with an aggregate value of $1 million or less (as adjusted for inflation).
- Minimum Payout QCFDAFs – The ACE Act also defines QCFDAFs to include DAFs sponsored by a QCF that are contractually obliged to distribute at least 5 percent annually.
- Nonqualified QCFDAFs – DAFs sponsored by a QCF that are neither size limited nor limited by minimum payout are “nonqualified community foundation DAFs” (NQCFDAF).
Charitable Contribution Deductions
- Timing – Individuals won’t receive an income tax deduction for gifts to NQDAFs or NQCFDAFs until the NQDAF or NQCFDAF makes a qualifying distribution to another charitable organization (other than a DAF). The amount of the donor’s deduction is further limited to the amount of the qualifying distribution out of the DAF.
- Property – Individuals won’t receive an income tax deduction for gifts of property other than cash, e.g., gifts of publicly traded stock, closely held or illiquid assets, real estate, art, etc., to NQDAFs or NQCFDAFs until the property has been sold and reduced to cash and then distributed to another charitable organization (other than a DAF).
- Illiquid Assets – Individuals won’t receive an income tax deduction for gifts of nonpublicly traded assets to QDAFs or QCFDAFs until the asset has been sold (but not distributed) by the DAF sponsor. The amount of the deduction is limited to the value credited to the DAF as a result of the sale, i.e., net of fees and costs associated with the sale. Compare the illiquid asset rule for gifts to QDAFs and QCFDAFs with the rule above for gifts of all property to NQDAFs and NQCFDAFs, which has a less favorable timing rule.
- IRS Information Reporting & Contemporaneous Written Acknowledgment – DAFs will be required to provide contemporaneous written acknowledgments to their donors in order for them to claim a charitable deduction for gifts to DAFs. The ACE Act further states what required contents the acknowledgment letter must contain to give effect to the new rules the ACE Act imposes. The same information will be required to be reported to the IRS. However, it’s unclear if the reporting vehicle will be a new IRS form or if it would be reported to the IRS using Form 1099 or indirect information reporting by the taxpayer on the next filed return using Form 8283 (noncash charitable contributions).
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