Are Donor Advised Funds a Black Hole of Philanthropy?
An article in The Atlantic recently criticized donor advised funds for locking up philanthropic dollar,s leaving local charities in need. Click here for a link to the article, The 'Black Hole' That Sucks Up Silicone Valley's Money, by Alana Semuels.
The article argues that donor advised funds have become black holes of philanthropy, offering a way for donors to park billions of dollars in funds, possibly years before the funds are actually used for charity.
Understanding Donor Advised Funds
To understand how this could happen, it is important to understand donor advised funds. Donor advised funds are gifts made to a charitable sponsor into a fund. The fund is earmarked for charitable purposes, but there is no requirement that the fund make distributions on any particular timetable. This leads to the possibility that a donor can make a charitable gift today, receiving a tax deduction today. However, the funds that may sit in an investment account for decades, possibly longer, before making their way to an actual nonprofit organization. Typically, funds are not disbursed until the donor makes a request for a grant to be made from the fund. (Technically, the charitable sponsor can disburse the funds to a charity at any time, but most sponsors prefer to follow the wishes of their donors most of the time.)
Philanthropy is Up, but Charitable Revenues are Down
The article, focusing on Silicon Valley, notes that over $2.2 billion was held in donor-advised funds from clients located in San Mateo and Santa Clara Counties in 2014, an almost 1,000 percent increase from 2005. These numbers come from the Giving Code's 2016 report about philanthropy in the Silicone Valley). At the same time, local charities in Silicone Valley were seeing their annual revenues fall, without any clear explanation.
A Lesson from Private Foundations
This issue has happened before, with donors receiving a charitable tax deduction years before the money made its way to operating charities. Congress responded with the numerous restrictions on "private foundations" under the current tax code. After abusive practices were noticed in some charitable foundations, Congress passed a series of laws in the 1960s that:
- Required private foundations to make minimum distributions each year;
- Imposed a tax on investment income from private foundation assets;
- Limited private foundations from holding control of business interests; and
- Prohibited private foundations from "self-dealing" with insider parties, like donors, family members, and board members.
Some of these restrictions, such as the self-dealing limitation and limitations on business holdings, already apply to donor advised funds. But donor advised funds are not currently required to make minimum distributions each year, meaning that a donor advised fund could sit for years without making any distributions to charity (or paying any taxes on accumulated investments).
New Distribution Requirements for Donor Advised Funds Possible in Future Legislation
The Atlantic article is only the most recent criticism against stagnate investments in donor advised funds. Many groups of have called on Congress to impose distribution requirements on donor advised funds. In the future, Congress may respond to these calls. Sponsoring organizations and donors should prepare for this possibility and monitor ongoing developments in this area.
What Should Donors Do?
With all the criticism of donor advised funds, donors should not be scared off from utilizing this important vehicle. Donor advised funds can be the perfect vehicle for many donors. For example, donor advised funds are easier and cheaper to set up and maintain than a private foundation. Donor advised funds can also be useful if a donor has excessive income in one year, such as when selling a business, but the donor has not yet formulated a long-term plan for supporting charity.
However, to avoid "parking" their money out of the hands of operating charities:
- Donors and sponsors should consider imposing distribution requirements on donor advised funds, even if not required by law.
- Sponsors should encourage donors to make annual distributions with frequent communications, even if distributions are not required by the fund agreement.
- Sponsors should make it easy for donors to recommend distributions from their fund by use of electronic forms and semi-automated verification processes.
- Donors should check in on their funds annually and should have plans for recommending periodic distributions from their donor advised funds.
- Donors should consider working with local, community-based sponsoring organizations for their donor advised fund, such as community foundations. Working with a local community foundation can help donors be aware of local concerns and causes that could benefit from their fund in a way that can't be replicated by larger sponsors that do not have deep ties to the community.
The calls for distribution requirements on donor advised funds are mounting, and The Atlantic article puts some solid numbers behind the issue. It remains to be seen whether Congress will act to impose a distribution requirement, or whether this is an area that will be left up to fund sponsors and donors.