3 min read
The facts in the Styles case as set forth by the donor are indeed, as one lawyer put it, "scary."

During 2002, a lucky gambler, Ray Styles, donated $2.5 million from an $8 million slot machine win to an IRC section 501(c)(3) charity. This was the sole contribution received by Friends of Fiji (FOF). The reported purpose of the donation was to establish a DAF (donor advised fund) account to be used to make grants to other charities. Among other things, FOF’s two officers used the donation to pay themselves lavish salaries, to purchase penny stock in a company in which one of the officers held an interest (later sold at a substantial loss), and to sponsor celebrity golf events.

Friends of Fiji also rejected Styles's advice for a DAF account grant to another charity. This prompted Styles to file suit seeking alternate remedies. The remedies sought included compelling FOF to distribute assets to another charity or to return funds to him. (A full discussion of the facts argued by the appellant can be found here.)

The lower court found that FOF “failed to attempt in any way to [honor the intent of the DAF agreement]” (framed as “satisfying Styles’s charitable goals”) and thereby “breached the implied covenant of good faith and fair dealing.” However, the lower court also found that by the express terms of the grant agreement Styles released any interest in money transferred to FOF because the gift was unrestricted. Thus, while true that FOF breached an implied covenant of good faith and fair dealing, because Styles expressly relinquished all interest in the transferred money, the court held he was not entitled to the relief sought: a compelled grant to another party or a return of remaining funds.

The Styles-FOF gift agreement expressly stated the gift to FOF was unrestricted. Because the gift was unrestricted, FOF was free to use the property as it saw fit (albeit subject to penalty should FOF run afoul of numerous state and federal rules governing use of tax-exempt funds). In turn, Styles relinquished all dominion and control in the gifted property. Accordingly, Styles was free to -- and did -- claim a charitable tax deduction for the value of the money transferred.

Had the courts found an implied, enforceable agreement between Styles and FOF allowing Styles to compel FOF to use contributed funds in a particular manner, the legitimacy of his tax deduction would be open to question. As would the legal foundation for tax deductible gifts to DAFs – relinquishment of dominion and control over contributed property, whether direct or indirect.

An old legal adage states “bad facts make bad law.” The Nevada courts could have made bad tax law given the truly bad facts presented by the Styles case. But, at least for tax law purposes, bad law did not result. A donor’s right to claim a charitable deduction in the year they fund a DAF account was strengthened by the Nevada courts holdings, rather than weakened. That said, the case does highlight the need for donors to educate themselves prior to opening a DAF account.

Donor-advised funds offer unique advantages compared with other charitable vehicles. Among these are cost effectiveness (both in dollars and time), virtually no administrative burden, low cost of entry compared with other charitable vehicles, and anonymous gifting. The Styles decision strengthens the legal foundation upon which DAFs rest. From this perspective, the Styles decision is favorable for both DAF sponsor organizations and their donors.

Donors to DAF accounts should recognize the advantages of DAF accounts are available only at the cost of complete relinquishment of dominion and control over contributed property. With this in mind, potential DAF donors should educate themselves fully concerning the DAF sponsoring organization before choosing an organization to house their account.

Potential donors should inquire as to the type of grants unlikely to be approved. They should consider the history of the sponsoring organization, and its board members’ backgrounds. For how many years has the organization been functioning? Does there appear to be an "institutional memory" at the sponsoring organization?  By reviewing the sponsoring organization’s Form 990, they can get a feel for the types of grants approved by the organization. As in the case of any major financial decision, which the decision to establish a DAF account surely is, caveat emptor rules the day.

Could a donor avoid the result in Styles by restricting a gift to a donor advised fund? Not likely. This is so mainly because a donor is unlikely to find a sponsoring organization willing to entertain restrictions on DAF account donations.

While it might be possible to fashion a DAF donation restriction, it appears the Internal Revenue Service disagrees. The IRS views material restrictions on amounts transferred to DAF accounts as evidence the property is received in trust rather than as a gift to a donor-advised fund. While strong arguments can be made that the IRS’s view is incorrect, most sponsoring organizations will avoid the issue altogether through a blanket policy of accepting only unrestricted gifts.

To read part 1 of "The Styles decision and DAFs," go here.

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