In a recent, unpublished decision (Styles v. Friends of Fiji ), the Supreme Court of Nevada affirmed a lower court ruling that a donor was not entitled to a return of a donor-advised fund account contribution or to compel a grant from the account. One highly credentialed attorney labeled the ruling “scary,” and a second was prompted to state, “Donors need to take steps to protect themselves when making restricted gifts.” However, it is not so clear that, from the standpoint of a well-informed donor and tax law in general, that the case holding is bad news. Indeed, it can be argued the ruling strengthens donor-advised funds.
Donor-advised funds (DAFs) have existed, in one form or another, for the past half century. Colloquially, DAFs are often referred to as “charitable checkbook accounts.” Operationally, a donor contributes assets to a tax-exempt entity (the sponsoring organization) with the understanding that the sponsoring organization will, upon the advice of the donor at a future date, consider the donor’s advice to grant account funds to some other charity (or to the sponsoring organization for its direct charitable projects or general operations). Sponsoring organizations send periodic statements to the donor detailing activities within the account. Usually, in addition to recommending grants, DAF advisors may advise among investment options for the DAF assets.
A number of DAF features are attractive to donors. Among these are: ease of administration compared to other giving platforms, such as private foundations; the ability to fund active charitable projects anonymously, which may not be possible using a private foundation or other charitable vehicles; a possibility to build a sizeable charitable giving pool through tax-free investment prior to deploying charitable capital for its ultimate use; and receipt of a charitable tax deduction in the year funds are transferred to a DAF account, even though funds held in the account may not be used for active charitable programs until some future year.
This last feature, as well as a number of questionable transactions some sponsoring organizations used DAFs for, caused the Internal Revenue Service (IRS) to cast a jaundiced eye on DAFs. Prior to 2006, the Internal Revenue Code (IRC) did not explicitly define DAFs or govern their operations. In 2006, Congress included amendments to the IRC defining a DAF as a fund or account (1) owned and controlled by a sponsoring organization, (2) which is separately identified by reference to contributions of a donor or donors and (3) where the donor or persons appointed by the donor may advise grants from or investment of assets held in the fund. Amendments governing various operational aspects of DAFs were enacted concurrently.
A primary concern surrounding charitable donations is if and when a donor may claim a charitable tax deduction. It is settled law that a gift is complete only if and when a donor relinquishes dominion and control over transferred property. Retention of even indirect control prevents a gift’s completion. This raises a dilemma for DAF accounts. If a DAF donor retains a right to direct future distributions from the account, how is it a charitable deduction is available in the tax year the account is funded?
The answer resides within a DAF account’s name -- the account donor’s "rights" in the account are advisory in nature only. Legally, a sponsoring organization is free to ignore such advice. Only because a donor relinquishes dominion and control over property transferred to the account, and has not retained a direct or indirect right to compel distributions from or use of account assets, may a donor claim a charitable deduction in any year the account is funded.
Note that if I make an unrestricted donation to a private foundation on whose board I sit, I have relinquished dominion and control over the donated property. This is true even though as a board member, I control the foundation grants. My control as a board member is by virtue of my fiduciary role at the private foundation, not as a result of retaining control in contributed property.
On Thursday, part 2 of "The Styles Decision and DAFs" will examine the Styles decision in detail and look at what it may portend for donor-advised funds.