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The Pension Protection Act of 2006, commonly referred to as H.R. 4, was signed into law August 17, 2006. The new law creates a new definition and new rules for donor advised funds-some of which take effect immediately, and some of which will take effect in the coming months. Below we provide some detailed Questions and Answers on these new regulations and how they affect our donors and our community. Tides Foundation has been following this legislation as it has evolved in Washington, and we are already taking steps to make sure that we remain in complete compliance with the law.
However, it is safe to say that the vast majority of grantmaking at Tides Foundation will not be affected by these new regulations. Grants to vital nonprofits recommended by donors through Tides funds will continue as they have for 30 years.
One key fact to keep in mind is that prior to this law the phrase "donor advised funds" was simply a commonly used business term and appeared nowhere in the Internal Revenue Code. This new law actively defines donor advised funds and outlines what is and is not allowed under the new definition, and what is allowed under other types of grantmaking funds.
With this new law, Congress has decided to apply many of the constraints applicable to private foundations to donor advised funds and supporting organizations. These include strict rules regarding self-dealing, excess business holdings, and certain taxable expenditures. As with any new legislation, there is much to be learned from the regulations that eventually will be put forward by the Treasury Department.
Below are a list of questions and answers on this new legislation. We will be updating this information as new information presents itself.
Please remember: This information is not intended to substitute for legal or tax advice. If you have further questions, we invite you to contact your Tides Foundation advisor or your own tax or legal counsel.
New Rules: Definitions of a donor advised fund
Taxable Expenditures: Limits on permissible grants and expenses
Insider Transactions: Tightening of restrictions on self dealing and direct reimbursements
Business Interests:
Miscellaneous
1. What has changed for donor advised funds(DAFs)?
In general, the new rules ushered in by this new law cover three areas of note to donors and advisors to donor advised funds:
2. How do I receive my tax deduction for a contribution to my DAF?
The donor must now have a receipt or gift acknowledgement from Tides Foundation that explicitly affirms that Tides has exclusive legal control over the contributed assets (which has always been the case for Tides DAFs). Our contribution acknowledgements at Tides Foundation will be revised to explicitly confirm this fact.
3. What exactly is a donor advised fund for these purposes?
Keep in mind that before these new rules were adopted, the term "donor advised fund" was not mentioned in the Internal Revenue Code and the term was used in philanthropic circles to refer to many types of fund arrangements. Only those funds which fall within the new definition are subject to the new, more stringent rules.
There are funds at Tides that are not "donor advised funds" as defined by the new rules; these funds will not be affected by the new rules (see "What is NOT a donor advised fund", below).
The new definition of donor advised fund includes only funds or accounts where all of the following conditions apply:
Funds will be subject to the new rules only if they meet all of the above criteria.
Keep in mind that a donor does not have "advisory privileges" if the donor's role is limited to designating the fund's purpose in the fund agreement. Similarly, the donor does not have "advisory privileges" if the donor's role is limited to recommending a category of individuals with expertise, based on objective criteria, to advise with respect to investments or distributions. For example, some funds utilize activist advisory panels to make grant recommendations.
4. What is NOT a donor advised fund for these purposes?
Tides Foundation will continue to hold funds that do not qualify as donor advised funds under the new definition. These funds, which are not affected by the new rules are detailed below. Grantmaking by such funds will be unaffected by the new rules:
For the latter two exceptions, it is not clear whether safe harbor guidance will be provided, or whether organizations will need to seek private rulings from the IRS in order to take advantage of them.
In general, donor advised fund grantmaking is now limited to grants to publicly-supported charities described in IRC Section 170(b)(1)(A). This definition of publicly-supported charities includes grants from DAFs to the general fund of the organization of which the DAF is a part (Tides Foundation, for example), and/or to another donor advised fund.
1. What grants are no longer permissible from my donor advised fund?
Under the new rules, the following types of transfers or distributions from a donor advised fund are not permitted:
2. Can a DAF make grants for legislative lobbying, or to a 501(c)(4) organization?
Generally speaking, a DAF can no longer make a grant to an organization that is not described in IRC Section 501(c)(3), unless the grant is restricted to charitable purposes. Accordingly, in most cases a grant to a Section 501(c)(4) organization to fund a lobbying activity will not be permissible. However, a grant to a Section 501(c)(4) may be permitted if the grant agreement expressly limits the use of the funds to charitable and educational activities and expressly prohibits the use of the funds for legislative lobbying.
Under the Treasury Regulations that have applied to private foundation grants, general support grants to other public charities described in IRC Section 501(c)(3) that lobby are permissible. Similar rules are expected to be adopted for grants by DAFs to public charities that lobby.
Tides Foundation will continue to support important 501(c)(4) advocacy work as we always have. We will also be following developments in the implementation of the legislation so that we can support these important efforts in a manner that complies with the new regulations.
3. Scholarships: What is necessary to operate a program that makes grants to individuals?
A fund can make grants to individuals for travel, study, or other similar purposes, but only if all of the following requirements are met. If all these criteria are met, the fund is a Scholarship Fund and not a donor advised fund.
4. Penalties: What are the penalties if a DAF violates any of these new rules?
Stiff penalties will apply to Tides Foundation, its managers, and, in the case of an impermissible private benefit, the donors and fund advisors for violating these new rules.
5. Can I still make international grants from my donor advised fund?
Yes. In general, international grantmaking at Tides Foundation will not be affected by the new law; however, grants to foreign organizations from donor advised funds require additional recordkeeping and pre-grant due diligence. Thus, these types of grants will be charged additional fees and will require longer processing times.
6. When are these new Taxable Expenditure Rules effective?
These changes are effective on January 1, 2007, for Tides DAFs.
In general, the new law prohibits any grant, loan, compensation, reimbursement, or other similar payment to donors and fund advisors, and "35% controlled entities." Covered entities, generally speaking, include any corporation, partnership, or limited liability company as to which the donor and fund advisors and their family members have voting control of 35% or more of the voting interests in the entity.
1. May I as the donor or as the fund advisor be paid from my donor advised fund for services I provide that are related to my grantmaking?
No. This is clearly prohibited.
2. What if I and/or a family member are compensated by a grantee organization that is a recipient of a grant from my donor advised fund?
At the moment, the answer is unclear. Tides' donors should contact their philanthropic advisor if they have specific questions on this matter. A restricted grant from a DAF to a grantee organization that compensates a donor or fund advisor to that DAF (or any of their family members), pursuant to a grant agreement which prohibits the use of that grant to compensate any of them, may be permitted. The specific facts of the situation should be discussed with your philanthropic advisor.
3. May I as the donor or as the fund advisor receive a loan from my donor-advised fund if I re-pay it with interest?
No.
4. Periodically I incur expenses such as going to conferences or purchasing supplies related to my charitable grantmaking. May I submit these expenses for reimbursement from my donor-advised fund?
No. These rules are effective August 17, 2006, so any expenses incurred prior to that date but processed after August 17 will not be eligible for reimbursement.
5. If I have appointed someone not related to me to act as an advisor to the fund, are they eligible to receive compensation for services, loans, or expense reimbursement?
No. That person is still a fund advisor, and subject to the same prohibition.
6. My company is in the business of providing services to charities. Can my fund buy services from my company?
No, if you or the fund advisors, or the family members of each, have voting control over 35% or more of the entity's voting interests, no compensation for any kind of services can be paid to the company. It is not clear whether the same rule will apply for purchases of goods from a 35% controlled entity.
7. When do these rules about Insider Transactions become effective?
These rules are effective as of August 17, 2006.
1. My donor advised fund currently holds an interest in a business enterprise. What do I do now?
The new rules apply the private foundation rules to business holdings of donor advised funds. As a practical matter, after January 1, 2007, donor advised funds will not be permitted to purchase interests in a business if, together with all "disqualified persons," the aggregate ownership interests in the business enterprise exceed 20%. These rules are exceedingly complex, and there are some exceptions.
If a DAF holds an interest in a business enterprise on the effective date of the new law (January 1, 2007), then the DAF must dispose of the interest in 10, 15, or 20 years, depending on the aggregate percentage interest of the holdings of the DAF and all disqualified persons. The DAF will have to dispose of the interest for fair market value, and a redemption by the entity or a purchase of the interest by disqualified persons may be problematic. Accordingly, the advisors to the DAF should consult with the sponsoring organization's counsel as soon as possible to determine an appropriate exit strategy.
2. I was planning to make a gift of appreciated securities this year. Am I out of luck?
You should still consider the gift with the help of your counsel, and counsel to the sponsoring organization, for several reasons. First, if the gift is made before January 1, 2007, the 10, 15 or 20 year transition rule described above (See Previous Question and Answer) will still apply to the gift, so that there will be a long time period for disposition of the interests. Second, there are some exceptions to the general rule described above, the most important of which is the exception for a de minimis holding by the DAF: if a DAF (and any related private foundations) holds 2% or less of the voting interests, the holding is permitted. Third, these rules generally consider only voting securities. Fourth, if another person actually controls the business enterprise, the permissible aggregate holdings are increased to 35%. And finally, some entities are not "business enterprises' at all (see following Question and Answer).
After January 1, 2007, if an interest in a business enterprise is given to a DAF, the DAF will generally be required to dispose of it not later than 5 years after the gift, subject to an extension of time if the IRS approves. This means that although such gifts are not prohibited, a clear and realistic exit strategy should be developed before such a gift is made.
3. What if my donor advised fund currently holds real estate, or if I wanted to make a future gift of real estate to my DAF? Is this permissible under the new legislation?
Possibly. A "business enterprise" does not include a business if at least 95 percent of the gross income is derived from passive sources, which generally includes rental income. Thus, a voting interest in an entity which holds rental real estate, or appreciated undeveloped or vacant real property, may not be a business holding at all. Similarly, a gift of an interest in real property held by you directly (rather than through an entity), is not subject to the prohibition on excess business holdings.
4. When are these new rules effective?
The changes to the rules applicable to excess business holdings are effective on January 1, 2007 for Tides DAFs.
1. What if I have my own private family foundation or sit on the board of a private family foundation? Were any changes made that affect private foundations?
Yes. The new rules may affect grants from a private foundation to a donor advised fund but only if the DAF is operated by a "Type III" supporting organization that is not "functionally integrated" with the supported public charity. Tides is not a "supporting organization," so there is no limitation on the ability of the private foundation to make a grant to one of its donor advised funds.
The new rules also increase the excise tax penalties for self-dealing, failure to distribute income, jeopardizing investments and taxable expenditures by private foundations. The calculation of net investment income for private foundations has also been modified to expand the definition of gross investment income.
2. Can a supporting organization still make grants to a donor advised fund?
Yes.
3. I have heard about the new rules allowing tax-free distributions from IRAs. Can I make a distribution to my DAF?
No. To take advantage of the new rule, which allows a tax-free distribution from an IRA to a charitable organization, the distribution must be to a public charity, but not to a DAF or a supporting organization.
Keep in mind, however, that a distribution to a field of interest fund at a public charity is allowable. In some circumstances, the tax-free distribution can be made to a private foundation-check with your tax advisor about whether your private foundation can receive a distribution from your IRA. The maximum amount of tax-free distributions from an IRA under these new rules is limited to $100,000 per year.
The information in these FAQs is summary in nature and is not intended to substitute for legal or tax advice. Grantmakers, donors and fund advisors should consult with their own counsel to determine the impact of this legislation on their particular circumstances. Any tax advice contained in this communication was not intended or written to be used, and cannot be used, for the purpose of (i) avoiding tax-related penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any tax-related matter addressed herein.
