Proposed Federal Tax Law Changes Affecting Private Foundations & Donor-Advised Funds

Thoughtware Article Published: Oct 06, 2021
Tax Advisor TW

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 of 2006 (PPA). On June 9, 2021, Sens. 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 the purpose of the ACE Act 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 Advisory Council’s (Council) recommendations, as well as a new coalition of philanthropists and foundations. The Council also made formal common-sense recommendations to Congress. 

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 will 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 will divide DAFs into various categories, including qualified and nonqualified DAFs. The major provisions of the ACE Act are outlined below.

Private Foundations

  • 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 would not 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 are subject to a 1.39 percent excise tax on their net investment income. 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 – Qualified DAFs (QDAF) will impose a 15-year limitation on advisory privileges 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.

    If a QDAF fails to pay out within 15 years, then the sponsoring organization of the QDAF must pay a penalty tax of 50 percent of the amount that has not been distributed. 
  • Qualified Community Foundations: Geographically Limited Community Foundations – A “qualified community foundation” (QCF) is a 501(c)(3) organization whose purpose is to understand and serve the needs of a geographic community that is no larger than four states and that has at least 25 percent of its assets held outside of DAFs. 

    Community foundations, for the most part, would not be affected by these new rules. The authors of the bill, recognizing the historical role of DAFs in community foundation funding, created a community foundation carve-out. No payout rules would be imposed on community foundation DAF accounts provided the account is $1 million or less. Accounts exceeding $1 million only need to distribute 5 percent a year, and distributions to the sponsoring community foundations (including annual fees imposed on the DAF account) would satisfy the payout requirements. 
  • Nonqualified DAFs – “Nonqualified DAFs” (NQDAF) are DAFs that have no time limitation or payout requirement.

    A contributor to an NQDAF would not receive an income tax deduction until the NQDAF makes a qualifying distribution to another charitable organization, which cannot be another DAF. The amount of the deduction is further limited to the amount of the qualifying distribution that goes to charity.

    Contributions of property—such as publicly traded stock, art, and real estate—to an NQDAF would receive no income tax deduction until the property is sold, reduced to cash, and then distributed to another charitable organization other than a DAF.

Charitable Contribution Deductions

  • Timing – Individuals will not receive an income tax deduction for gifts to NQDAFs until they make 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 will not receive an income tax deduction for gifts of property other than cash (including, for example, gifts of publicly traded stock, closely held or illiquid assets, real estate, art, etc.) to NQDAFs until the property has been sold and reduced to cash and then distributed to another charitable organization (other than a DAF).
  • Illiquid Assets – Individuals will not receive an income tax deduction for gifts of nonpublicly traded assets to QDAFs 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. 
  • 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 the 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 is 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).

As stated above, the purpose of the ACE Act is to reform PFs and ensure that DAFs make resources available to working charities within a reasonable period of time. Although the bill is unlikely to pass in its entirety, it is highly possible that some of the proposed changes will make their way into other legislation. This is particularly true because the ACE Act is considered bipartisan, as Sen. King is an independent but caucuses with the Democrats.

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