A new bill in Congress by Senators Angus King (D-ME) and Chuck Grassley (R-IA), S. 1981, the Accelerating Charitable Efforts (ACE) Act, posits several sweeping policy changes for donor-advised funds (DAFs) and private foundations (PFs). The ACE Act has generated controversy in the philanthropic community. Supporters argue that it will ensure that funds earmarked for charitable purposes reach charitable beneficiaries quickly. They believe that the provisions of the ACE Act will prevent DAFs and PFs from holding onto funds indefinitely without distributing them to charities. Opponents say that these modifications aren’t supported by the data and, moreover, could have a chilling effect on charitable giving by limiting when donors will be able to take their charitable deductions.
Here’s our analysis of the ACE Act’s provisions and its implications for your clients.
ACE Act Changes
The ACE Act makes a number of changes affecting DAFs and PFs.
PFs. PFs are currently required to pay out at least 5% of their endowments each year. The ACE Act limits how a PF may meet this goal by providing that PFs can’t meet their 5% payout requirement by making grants to DAFs, even if a PF is using a DAF, for example, to act as a convenient repository for grants from joint venture PF partners for a new charitable venture. In addition, PFs won’t be able to meet their 5% payout requirement with travel and compensation expenses of family members employed by the PF, like Melinda French Gates, who travels the world pursuing a more equitable future for girls and women.
Charitable donors and DAF sponsoring organization. Under the ACEAct,charitable donors to DAFs will have to choose between two types of sponsoring organizations, qualified or not qualified (see definition below). Based on the current wording in the ACE Act, most aren’t qualified. Those charitable donors who choose non-qualified sponsoring organizations would then have to decide on a 15-year DAF or a 50-year DAF, and the tax consequences will vary depending on their choice. If they choose 15 years, they’ll get an upfront charitable deduction. If they choose 50 years, they’ll have to wait to get their charitable deduction until the funds are disbursed from the DAFs. There are currently no term limits or minimum distributions for DAFs, and donors receive a charitable income tax deduction in the year that they make a contribution to their DAF.
For those who choose a 15-year term limit, the ACE Act would essentially require that all earnings, fees and distributions be tracked for each contribution to a DAF. Who’s responsible for all this tracking? It’s unclear but our bet is that it won’t be the Internal Revenue Service. They’re already understaffed, and any new budget won’t go to the tax-exempt division to monitor the non-profit sector. They’ll get more bang for their buck elsewhere. We suspect once the dust settles, the DAF sponsoring organizations will be tagged with signing, under penalties of perjury, that the DAFs they manage are in compliance.
Qualified community foundation (QCF) exemption. The ACE Act exempts from most of its provisions DAFs with less than $1 million at QCFs that serve a geographic area not to exceed four states. So does this narrow exemption mean that supporters of the ACE Act believe that DAFs at national sponsoring organizations like the Salvation Army or charitable networks like the Jewish Federations of North America are per se problematic?
Charities. Charities are in the DAF business. Some (for example, American Heart Association and United Way Worldwide) sponsor their own DAFs, while others enjoy the ease with which they receive the funds—without lengthy applications and reporting requirements. We believe changing that dynamic isn’t progress. It’s exactly the opposite.
Limitations on the deductibility of illiquid assets to DAFs. The ACE Act also introduces a different set of rules for gifts of certain illiquid assets to DAFs than the rules that apply to the same outright gifts to public charities. This doesn’t seem likely to increase the flow of dollars from DAFs to public charities, so we’re not sure why this is included in the ACE Act.
Are DAFs Procrastinators?
Some argue that charitable donors with DAFs are procrastinating when it comes to the outflow of those DAFs to other charities. For context, let’s look at the numbers. According to the National Philanthropic Trust, grantmaking from DAFs to qualified charities totaled more than $25 billion in 2019, a 93% increase since 2015.1 The same rapid growth trajectory also applies to contributions to DAFs, which totaled $38.81 billion in 2019.2 This represents an 80% increase in contributions since 2015. And according to National Philanthropic Trust’s formula for calculating the distribution rate, distributions from DAF sponsoring organizations, as a percent of the starting balance, has ranged from 15% for community foundations to 30% for single issue charities.3
This is a distribution rate that’s more than three times the average distribution rate of PFs. It’s four or five times the distribution rate of endowment funds. So why single out DAFs? If there are some DAF procrastinators, they seem to be a distinct minority.
Boston College law professor Ray Madoff and others assert in a paper that the correct formula for calculating distribution rates for DAFs should include new contributions and investment returns in the formula, resulting in an average distribution rate of 15%.4 Were this same formula to be applied to PF distributions or endowment grants, their payout rates would be well below 5%.
Furthermore, of the issues facing the charitable sector right now, many are rightfully asking just how big of a problem all this is. No one knows. And that’s at the crux of complaints about the ACE Act. It posits several sweeping policy changes—for both DAFs and PFs—based on too many anecdotes and inconsistent data, including from Fidelity Charitable, the Community Foundation Public Awareness Initiative and the Ray Madoff and National Philanthropic Trust paper noted above.
Proponents’ Concerns
So what’s behind the Senators’ interests in the ACE Act? Sen. Grassley is concerned that “…charitable dollars ought to be doing the good they were intended for, not sitting stagnant to provide tax advantages for some and management fees for others.”5 So the ACE Act seeks to force donors and some PFs to ramp up their grantmaking. Or in the case of DAFs at non-qualified sponsoring organizations, face a 50% tax on undistributed dollars after 15 years.
But members of Congress introduce lots of bills, most of which end up nowhere. Why is the ACE Act galvanizing so much interest and controversy in the charitable sector? One reason is that Sen. Grassley has a long and prolific history with the sector. He single-handedly pushed through sweeping policy changes in the Pension Protection Act of 2006 that touched every part of the non-profit sector, including charitable donors. Among his colleagues, that makes Sen. Grassley the current expert in Congress on the sector and, not surprisingly, many look to him for cues on charitable policy issues.
Also driving interest is the belief that while this specific bill is unlikely to become law in its present state, Sen. King and Sen. Grassley might also be interested in using the threat of legislation to influence charitable donors’ behaviors. Sometimes the threat of legislation can prompt voluntary, and profound, effects.
Back in 2007, Sen. Grassley, lead Republican on the Senate Finance Committee, began a public inquiry into the growing endowments at well-heeled universities. His intent seemed to be to juxtapose their enormous endowments with the piddling amount of scholarships offered. At the same time, Sen. Grassley pondered aloud in the press whether universities ought to be required to be more generous with scholarships or risk their tax-exempt status.5
What happened? Harvard, Yale and Dartmouth announced a new and very generous policy offering increased student aid.
Back to the ACE Act. Many sponsoring organizations currently impose “dormant fund” policies. Perhaps the threat of this legislation will lead others to adopt similar rules.
Other Initiatives
In a bigger context, many in the charitable sector have expressed frustration that all the attention to the ACE Act is crowding out other priorities already teed up this year in Congress. For example, they’re espousing to expand the universal charitable deduction (expiring at the end of 2021), which offers up to a $600 charitable deduction for non-itemizers. The largest charities are concerned that this could slip away if attention and advocacy efforts continue to be captured by the ACE Act.
This all may seem quite sudden to you, but for years, critics in the sector have charged philanthropists with good intentions but sometimes plodding actions. The pandemic threw gas on that long simmering flame, and the result was a concerted campaign to, at first, appeal to donors to, for example, half their DAFs.6 This was followed by the Initiative to Accelerate Charitable Giving,7 supported by billionaires John Arnold and Ray Madoff. Arnold and Madoff found a home for their roadmap to mandate how Congress could force donors to disburse funds more quickly from DAFs—and that home is the ACE Act.
Implications for Clients
Let’s turn to some not-so-obvious implications of the ACE Act for your clients:
Deceleration of charitable giving. The ACE Act intends to accelerate charitable giving through its reforms. But DAFs have been superb vehicles to create liquidity for charitable good and sustain multigenerational giving, and the ACE Act may have unintended consequences that may decelerate charitable giving. The ACE Act changes the tax treatment of illiquid assets, such as real estate interests, privately held businesses and collectibles like art, so that they’ll be treated how used automobiles currently are under the IRC. That is, the deduction will be limited to sales proceeds. It’s possible that limiting deductibility to the actual sales price received by the DAF will discourage giving to the very entities with considerable expertise with hard-to-handle and value assets. Only the most heavily endowed charities could replicate this expertise.
Administrative burden. The 15-year rule is intended to increase the dollars distributed annually from DAFs, but it would create an administrative burden that could have the opposite impact. Most DAFs are more like checking accounts than savings accounts, with high levels of distributions and regular contributions to replenish the DAF. Keeping track of each contribution and the grants, investment return and fees associated with each contribution will be expensive and likely result in smaller charities and mission-based charities getting out of the DAF business.
Three categories of DAFs creates confusion. The ACE Act splits DAFs into three categories, each with different tax treatment and minimum distribution rules. Those DAFs with assets less than $1 million and housed by QCFs would get preferential treatment in that they’re exempt from these rules. This is strange, given that the data indicates that these QCF DAF programs currently distribute the lowest percentage of their assets annually.8 Mission-based and single issue national or regional DAF programs would be treated the same as all other DAF programs, which is also strange, given these programs’ high distribution rates. Adding this level of complication and confusion without a clear public policy rationale likely won’t lead to a higher level of distributions from DAFs.
Multigenerational family giving discouraged. For the first time, there would be a dollar limit on multigenerational advisory privileges. Specifically, for QCF DAFs, the maximum values of the advisory privileges without term limits for one individual would be $1 million. Aside from creating yet another administrative accounting function, how is one individual defined? Are all bloodlines of the donor’s family aggregated? Is the limit in effect the $1 million limit or the $1 million limit multiplied by as many family members as the original funder can find? When is the $1 million determined during the year? Or is it an average through the year or a trailing average?
DAFs are one of the ways that donors get a current income tax deduction for irrevocably committing assets to benefit society now and in the future. Many charitable organizations are only able to provide the current level of service today because far-sighted donors established endowment funds years ago and received charitable income tax deductions at the time the dollars were contributed. Most would argue that this is good for society. The wealthiest U.S. families have long used PFs for this purpose, resulting in more dollars being distributed to the non-profit sector. A central feature of PFs is the engagement of future generations in the philanthropic activities of the family. DAFs provide similar opportunities for moderately wealthy families. Why should DAFs not also allow for this type of intergenerational engagement? It’s in the public interest to motivate families to put aside assets for their heirs to distribute to charity. Given the negative consequences in setting an arbitrary termination duration for DAFs, we don’t think this is the best way to achieve the stated goals of this legislation.
What Comes Next?
For a number of reasons, the ACE Act is expected to hang around, without advancing far. For starters, there’s no demonstrated support for it in the House of Representatives, and Congress is loathe to pass legislation that requires it to pick sides within the charitable sector.
As noted above, enacting a bill isn’t necessarily the end game here. What the ACE Act is doing very effectively is generating a lot of public soul-searching in the community on the issues it raises that have been bubbling below the surface for years.
Could some in the sector propose voluntary standards and certifications for those that meet those standards? Could alternative legislation be sought that requires those that manage DAFs to take some action if DAFs go dormant? Or could this heightened attention on the practices of DAFs generate something altogether different?
One important step forward would be for stakeholders to ask the Treasury Department to update their 2011 study on DAFs,9 which, based on 2006 data, found that the timing of inflow and outflow from DAFs wasn’t dissimilar from inflow and outflow of other public charities that operate charitable funds or maintain endowments. Because of the huge growth in DAFs as a popular giving vehicle since 2006, another study seems very timely. This study could even point to discrete policy changes that are supported by legislation.
— This material contains the opinions of the authors, but not necessarily those of AllianceBernstein or its affiliates or other institutions affiliated with the authors and such opinions are subject to change without notice. Bernstein does not provide tax, legal, or accounting advice.
Endnotes
1. www.nptrust.org/reports/daf-report/”www.nptrust.org/reports/daf-report/.
2. Ibid.
3. Ibid.
4. www.nber.org/papers/w27888.
7. Supra note 4.
8. Ibid.
9. www.treasury.gov/resource-center/tax-policy/Documents/Report-Donor-Advised-Funds-2011.pdf.