Why can’t I fulfill the pledge to my favorite charity from my donor advised fund?
IRS rules prohibit a donor from fulfilling a legally enforceable pledge with a payment from a donor advised fund (DAF). Some background information surrounding a DAF will help explain this issue.
Donor advised fund
The term donor advised fund refers to an account held at a sponsoring organization, often a community foundation. The DAF is owned and controlled by the sponsoring organization and the donor retains only advisory privileges over the distribution or investment of the funds in the account. When a donor makes a contribution to a DAF, the sponsoring organization has legal control over it and the donor is eligible to take a charitable tax deduction for this completed gift. It is important to note that even though the donor has retained “advisory” privileges over the money in their DAF, the owner of the funds is the sponsoring organization and all funds are ultimately controlled by the sponsoring organization. The donor is limited to making recommendations only. While most sponsoring organizations will routinely approve a donor’s request, it is under no legal requirement to comply with a request.
Fulfilling a legally enforceable pledge
Since the donor has advisory privileges over distributions from the DAF, many donors believe they can simply request a distribution from their DAF to fulfill their legally enforceable pledge. But the money held in the DAF belongs to the sponsoring organization, not the donor, and the donor can’t legally obligate the DAF.
A charitable pledge is an obligation of the donor to give money at a future time. If the sponsoring organization (the owner of the funds) relieves the donor of the obligation to fulfill their pledge, the donor is receiving an impermissible “prohibited benefit.”
Donor tax: A tax of 125 percent of the prohibited benefit resulting from the distribution may be imposed on the donor who received the prohibited benefit.
Fund manager tax: If a tax is imposed on a prohibited benefit received by a donor, a tax of 10 percent of the amount of the prohibited benefit may also be imposed on any fund manager who agreed to the distribution knowing that it would confer a prohibited benefit.
Many community foundations with donor advised funds are sending letters along with the checks they issue to charities, asking the recipients of funds to certify that the monies are not being used to fulfill a legally binding pledge. Sometimes, this is the first time the recipient organization learns that the donor intended to pay their pledge from a DAF. Usually the donor is unaware of the associated excise taxes involved.
Charitable organization’s risk and responsibility
The charity receiving the contribution from the DAF is not subject to any excise taxes relating to these transactions; however, the risk of alienating donors and the community foundations involved in these prohibited transactions could be significant.
Many charitable organizations have set up procedures to record a non-binding gift intention. This is not a legal or binding commitment, but rather a courtesy notification that the donor intends to request that the DAF make future gifts to the organization. The donor would make a request from their DAF each time they wish to make a contribution to the charity, based on their non-binding commitment, but there is no legal requirement that they do so, and no obligation for their DAF to agree to the request.
Organizations should exercise care when thanking a donor for making a request from a donor advised fund. The thank you letter should not thank the individual donor for the donation, but instead should thank the donor for “recommending that the John Doe donor advised fund make a contribution to our organization.”
It’s good policy for all charitable organizations to understand the rules surrounding donor advised funds and be able to advise donors regarding the best ways for them to provide continued support.
For more information on this topic, or to learn how Baker Tilly specialists can help, contact our team.
The information provided here is of a general nature and is not intended to address the specific circumstances of any individual or entity. In specific circumstances, the services of a professional should be sought. Tax information, if any, contained in this communication was not intended or written to be used by any person for the purpose of avoiding penalties, nor should such information be construed as an opinion upon which any person may rely. The intended recipients of this communication and any attachments are not subject to any limitation on the disclosure of the tax treatment or tax structure of any transaction or matter that is the subject of this communication and any attachments.