How Do We Fix Abuses of Donor-Advised Funds?

The many companies that market Donor-Advised Funds (DAFs) are very direct in publicizing their advantages.  In one chart, comparing DAFs to private foundations, the American Endowment Foundation extols the virtues of DAFs in one comparison chart:

Donating closely held stock or real estate? How big a deduction?

DAF: Fair Market Value

Private foundation: Cost basis

Annual distribution requirement?

DAF: None

Private foundation: 5 percent

Confidentiality:

DAF: Flexible: Donors can choose full/partial recognition or complete anonymity

Private foundation: None, all information is publicly available

This exposes several problems with DAFs.  Donors get substantial tax deductions, including for complex appreciated assets, when they place funds into a DAF.  But they have no obligation to distribute the funds to qualified charities.   And donations from DAFs are not transparent.

These are fundamental design flaws in what should be understood as a taxpayer-subsidized endeavor.  We explore this in a new IPS Inequality Policy Brief: Fixing What’s Broken with Donor-Advised Funds.

We are living in a time of unprecedented social and environmental challenges. As we try to cope with them, wealthy individuals are using donor-advised funds, or DAFs, to claim substantial charitable tax breaks, while often failing to move that revenue out to working charities serving the public.

Right now, an estimated $160 billion is currently stockpiled in DAFs, and that amount is increasing every day. DAFs have been the fastest-growing recipients of donations in the nonprofit sector for the past twenty years, and are now the largest recipients of charitable giving in the United States.

Until just a few years ago, the largest recipients of charitable giving in the US had always been working charities such as the American Red Cross, and the Salvation Army. In 2016, however, for the first time, the largest recipient of charitable giving in the US was a commercial DAF sponsor: the Fidelity Charitable Gift Fund. For the past five years, six of the ten top charities have been DAFs. And by 2020, DAF giving had grown to the point where donations to Fidelity Charitable were almost triple those received by the United Way, and almost six times those received by the Salvation Army.

This means that each year, disproportionately more and more charitable revenue is being diverted into DAFs while nonprofits on the ground struggle harder for funds. According to a recent analysis, the explosive growth of DAF giving has led to the diversion of $300 billion from working charities into intermediaries such as DAFs over the past five years alone.

To make matters worse, in the absence of adequate regulation and transparency, DAFs are ripe for abuse by donors and for-profit actors alike.

Fund management fees, DAF administrators’ salaries, and bonuses for account advisors who recommend the DAF to their clients are often based, at least in part, on the amount of assets held in the DAF. There is currently no way to track donations from individual DAF accounts, which means that DAFs can be used as sources of “dark money”—funding designed to promote specific public policy while the funders remain undisclosed. DAF donors are currently able to take a tax deduction for the donation of complex assets such as artwork, antiquities, and real estate—assets which are notoriously difficult to appraise, and which may be assessed at a significantly inflated value. And while DAFs were meant to be revolving funds moving revenue quickly out to charities, newly-popular and often illiquid impact investing strategies are jeopardizing the timely distribution of DAF assets.

It is important to remember that we, the American taxpayer, have an interest in ensuring that donor-advised funds move revenue to charities in a timely way. Wealthy donors reap significant tax savings from DAF giving, and these savings are subsidized by the rest of us through the charitable deduction and other tax reductions to the tune of up to 74 cents on every donated dollar.

In our new policy brief, Fixing What’s Broken with Donor-Advised Funds, we lay out a set of policy recommendations that would correct the flaws in the design of DAFs. All of the solutions we propose are designed to ensure the public an appropriate return on our tax subsidy of DAFs. And these solutions would incur no new revenue costs to the public, since the charitable deductions related to DAFs have already been paid for by the U.S. taxpayer.

First and foremost among our recommendations is to require DAFs to pay out at a specified minimum annual rate. Currently, DAFs have no minimum payout requirement, and establishing one would discourage the warehousing of charitable revenue and increase the flow of revenue out from DAFs to charities. Based on our research, mandating a 10 percent payout rate for donor-advised funds on a per account basis would generate at least $3.5 billion, and potentially as much as $12.6 billion, in additional funds for charity each year.

We also recommend a number of other steps we can take to ensure that DAFs provide an adequate return to the public, to make sure that DAF distributions go to working charities, and to protect the fairness and integrity of our tax system. These include measures such as requiring DAF distributions within a set number of years; delaying tax deductions until funds are granted out; discouraging DAF grants from going to other DAFs, and requiring greater transparency and standardized reporting about DAF grants.

Donor-advised funds have been skyrocketing in popularity, and that pace is unlikely to slow down anytime soon. A steadily increasing share of charitable dollars is shifting away from working charities and pouring into DAFs each year. But the rules around DAFs are currently broken, and this encourages and enables ultra-wealthy individuals to use DAFs as a tax avoidance strategy. We can rewrite these rules to make sure that DAFs are actually used as instruments for the greater good.