History
Beginning in the 20th century, civic leaders in major cities across America started community foundations as a way to encourage affluent individuals and families to make permanent charitable investments in their communities. Unlike private foundations, which private individuals create and control, community foundations are public charities that are subject to oversight by an independent Board of Directors or Trustees comprised of individuals who are qualified to represent the best interests of the local community. Because community foundations are more accountable to the public and operate more transparently than private foundations, contributions to community foundations are treated more favorably for tax purposes than private foundations.
The first donor-advised funds generally date to the 1930s, when they were mostly associated with community foundations. In 1992, Fidelity Investments started a commercial donor-advised fund ("CDAF") and other firms have followed, including Charles Schwab, Vanguard, and T. Rowe Price. These funds generally charge both an administrative fee to the donor and a fee to the money manager.
Because a contribution to a donor-advised fund is a completed gift to a charity and the fund has legal control over the distributions, the donor can take an immediate deduction for the contribution. For practical purposes, however, by retaining a right to make recommendations regarding distributions, the donor is able to have significant input regarding when and to whom the payments will be made. Some donor advised funds end at the original donor’s death, while others allow the children and, in some cases, later generations to make recommendations.
The benefits for donors who establish donor-advised funds include their simplicity, especially as compared to private foundations, where the paperwork can be complex. Not only is the paperwork simpler; but, also, the rules are more generous since they follow the rules for general charitable contributions (i.e., the limits on giving as a percentage of income are higher (50% as compared to 30%) and the limits on gifts of appreciated property as a percentage of income are more generous (30% compared to 20%)).
Because the tax code treats contributions to donor-advised funds more favorably than ones made to private foundations, since the introduction of CDAFs by Fidelity and other investment firms in the early 1990s, the U.S. Congress and Treasury Department have examined whether, in the future, CDAFs should be treated less favorably for tax purposes than traditional donor-advised funds. The reason for such a possibility is that, when first created in the 1930s, donor-advised funds were seen as a means for wealthy donors and community foundations to regularly communicate about and meet the charitable needs of their communities. By encouraging philanthropists who otherwise might hold their charitable assets in a private foundation to create a donor-advised fund at a community foundation, Congress and the Treasury Department saw an opportunity to create a channel for more effective philanthropy.
In short, Congress and Internal Revenue Service officials in the Treasury Department are concerned about the features of CDAFs that distinguish them from community foundations, making CDAFs more like private foundations.
One concern of Congress and the IRS is that CDAFs often serve as a mere "rubber stamp" for the distribution recommendations made by the advisors to the funds, a result, which, in essence, makes CDAFs "donor-directed" funds that undermine the intent of the law and regulations governing "donor-advised" funds. CDAFs are typically national foundations, the board members or trustees of which usually reside well outside of the communities in which their donors reside. In most cases, these board members and trustees are unaware of the charitable needs of the communities in which their donors reside and are not in a position to help fund advisors make distribution recommendations that will positively impact their communities. In essence, the donor-advisor makes a recommendation, the CDAF confirms the qualified tax-exempt status of the designated recipient, and the CDAF makes the distribution accordingly.
A second concern of Congress and the IRS is that, because CDAFs earn a fee for the assets held in the funds for which they serve as investment advisors, the CDAFs do not have the incentive to encourage the advisors to the funds to make significant distribution recommendations. Thus, because donor-advised funds are not subject to the minimum distribution rules to which private foundations are subject, donors to CDAFs are able to accumulate the fund assets, thereby depriving the community of much-needed support.
On July 11, 2012, the Congressional Research Office published a report in which it explained the questionable CDAF practices that warrant possible consideration for Congressional action. Ironically, 20 years earlier, GCF Founder Jim Kelly closely examined the design and operational differences between CDAFs and the donor-advised funds operated by community foundations. Anticipating that the Treasury Department might be concerned about the creation and growth of CDAFs relative to traditional donor-advised funds, on September 29, 1992, Jim met with IRS officials in Washington, D.C. As a result of that meeting, and with the encouragement of the IRS officials, Jim prepared and submitted a private letter ruling request to the IRS. In the letter ruling request, Jim detailed how GCF would create and operate its donor-advised fund program in full compliance with applicable tax laws and regulations. This private letter ruling request provided the IRS Exempt Organizations Rulings Branch with a vehicle for implicitly distinguishing between CDAFs and donor-advised funds operated by community foundations. On December 7, 1993, the IRS issued the desired private letter ruling to GCF (the "Ruling"). In the Ruling, the IRS confirmed that GCF's donor-advised fund program, as described in the private letter ruling request, met all of the significant facts set out in the applicable federal income tax regulations and qualified for the favorable tax treatment afforded donor-advised funds. Although other community foundations cannot rely on the Ruling for their tax purposes, this rare, landmark Ruling clearly sets forth the design and operational factors that all community foundations should follow to avoid the fate that CDAFs, in the not-to-distant future, may suffer at the hands of Congress and the IRS.