Charitable contributions to donor-advised funds (DAFs) are growing, and at an increasing rate. According to one study, $1 out of every $8 given to American nonprofits went to DAFs, which allow the donor to reap tax benefits and accumulate resources for later philanthropic giving. DAFs were originally designed to be an efficient, tax-advantaged alternative to the creation of a private foundation and, in many ways, they continue to serve that function by being low-cost and requiring minimal paperwork. However, as the DAF sector has grown in popularity, it has also become increasingly controversial, as critics have accused these funds of being unaccountable and a means for stockpiling philanthropic lucre. This essay looks at how DAFs might be misused and possible ways of correcting these problems.

Origins, including original intent

The idea of DAFs originated with the New York Community Trust in the 1930s. The community trust wanted to find a means to build assets and, at the same time, help donors who had wealth but no interest in creating a private foundation. Unlike the trust departments of banks that provide a range of charitable and noncharitable services, the goal was to create a vehicle specifically focused on philanthropy. The solution was to establish funds, administered and managed by the trust, through which donors could make contributions, receive the appropriate tax benefits, and avoid the costs and reporting requirements related to private foundations. An individual or family could donate in cash to create a DAF and receive a charitable deduction.  Alternatively, they could give appreciated stock or other property and receive a charitable deduction, as well as avoid paying capital-gains tax on the assets. The sponsor would then work with the donor to select appropriate recipients for the DAF’s resources.

The 1969 Tax Reform Act provided an additional incentive for donors to give their money through DAFs. DAFs are treated as public charities under the ’69 reforms and contributors are eligible for deductions of up to 60% of their adjusted gross income if they give cash and 30% of their income on the value of appreciated assets. By contrast, if they create a private foundation, they are only able to receive a deduction of up to 30% of their adjusted gross income for cash and 20% for appreciated assets. The favorable treatment of DAFs reflects the assumption that the money in these funds would be quickly disbursed to working nonprofits, as opposed to foundations—endowed institutions not likely to disburse all or most of their assets in a few years.

This idea caught on quickly with other community foundations, Jewish Federations, and other nonprofit sponsors that had an interest in and the capabilities to manage DAFs. In 1976, the Tides Foundation was created to sponsor DAFs for donors interested in social change and left-of-center politics. In 1999, DonorsTrust was created to serve the same function for conservative and libertarian philanthropists. Most significantly, Fidelity Investments created a charitable arm in 1991, which marked the entry of major financial institutions into this market. Today, Schwab, Bank of America, and dozens of big corporations have followed suit. By some estimates, more than $170 billion is now housed in DAFs, with the vast majority under the sponsorship of for-profit entities.

Four concerns

DAFs are often promoted as alternatives to private foundations. Indeed, Fidelity Charitable suggests that, in naming your DAF, you may want to call it, say, the Frank Smith Giving Foundation. However, there are a number of significant differences between these two approaches to charitable giving. The tax benefits for creating a foundation are lower than those for a DAF. Foundations have public reporting requirements dictated by the Internal Revenue Service (IRS). The reports, the 990-PF, document the governance of the foundation, its costs, and the recipients of its grants. Moreover, foundations are required to distribute 5% of their assets each year, although the direct expenses of making grants counts toward that requirement. None of this applies to DAFs. While the sponsor may report on its cumulative work, it is impossible to see the choices of recipients made by the donors. DAFs are not subject to the 5% distribution requirement—so, in theory, a wealthy person could donate millions in appreciated stock to create one of these funds and never give away a dime. 

In the past few years, multiple concerns have been raised about DAFs and the DAF industry. The first and most prominent is the accusation that DAFs allow wealthy people to warehouse money that should be going to active nonprofits serving the public. The tax benefits of contributing to a DAF are the same as those for a working nonprofit. However, without a distribution requirement, there is no pressure on the donor to actually put her money to work. Since control of DAFs can be handed on to the donor’s heirs, there might even be an incentive to stockpile money so that the next generation can make their philanthropic mark. The sponsors, especially the for-profit institutions, have no incentive to encourage grantmaking because they are compensated through management and investment fees and those fees are directly linked to the amount of money in the DAF.   

A second criticism relates to transparency. Individual DAFs do not have to report their grants and most sponsors allow donors to make anonymous gifts. As a result, there is no way to ever see how this money, encouraged and often enhanced by tax benefits, is being used. However, we do know that some private foundations who may want to make grants that are controversial or politically adjacent, like voter motivation and education, create DAFs and channel their contributions through them to avoid public scrutiny. 

A third and related problem is that foundations may use DAFs not just for anonymity in grantmaking, but also to meet their annual 5% distribution requirement. In doing so, the foundation avoids its own payout commitment and creates a stockpile of money outside of public scrutiny. While this maneuver is legal, it certainly seems to violate the intent of the law and regulations concerning distribution. This issue was a major concern of Congress in the 1960s, when foundations were under no obligation to make any grants on an annual basis.

The final point has to do with using DAF resources to support not just §501(c)(3) public charities, but also §501(c)(4) social-welfare organizations. The latter are allowed to engage in a much-broader range of lobbying and election-related activities than the former. While appreciated assets can be donated to (c)(4)s with no negative consequences, you cannot receive a charitable tax deduction for these gifts. Legally, (c)(3)s, like DAFs, can make grants to (c)(4)s if the funded work is aligned with the donor’s mission. Fidelity, for example, makes it clear that DAFs under its sponsorship are limited to (c)(3) entities; other sponsors take a broader view. DonorsTrust and some other more-ideological sponsors on the left and right are simply silent on the issue and refer to “eligible” or “legitimate” recipients. However, others, like the Tides Foundation, are more open and even mention additional legal expenses for DAFs that are making “grants that intersect with political activities.” Donors can thus reap full tax advantages and deductions by giving to a DAF and then support a (c)(4) group for activities that would not be eligible for these benefits.

Four elements

How should we tackle these four challenges? Currently, there is pending legislation, the Accelerating Charitable Efforts (ACE) Act, that would push DAFs to give more money faster. This proposed law was designed, it seems, to create an effective coalition for passage and, as a result, it is complicated. One part of the legislation focuses on private foundations and contains provisions that would encourage higher distributions to “working nonprofits” and discourage the use of DAFs as a means to meet their payout requirements. For example, salaries and expenses paid to members of the donor family could not be counted towards the foundation’s distribution requirement. However, interestingly enough, ACE would allow foundations to make grants to DAFs as long as the DAF made a grant to a working nonprofit in the same year. While this would discourage warehousing resources, it would still allow foundations to make anonymous grants through these third-party vehicles.

The DAF-specific portions of ACE are focused primarily on reducing the use of these funds as storehouses for charitable resources. Potential creators of a DAF would have to choose between a nonprofit sponsor, like a community foundation, or a for-profit one. If you opt for the latter, then there are other choices in terms of how long the money can be in the DAF and when the donor would actually receive the tax benefits connected to this transaction. In most cases, an actual grant to a working nonprofit would have to be made from the DAF before the initial donor receives a deduction. For community foundations, DAFs with more than $1 million would have disburse at least 5% of their assets each year if the donor wants to receive a charitable deduction. In order to avoid overvaluation by the donor, donations of non-publicly traded assets, like real estate, would only generate a deduction for donor when the asset is actually sold.

There is much to praise in the ACE Act. However, here’s an alternative approach that might be easier to implement, but possibly less politically palatable. This plan would have four elements. First, DAFs would be treated as the same as private foundations. Contributions to foundations and DAFs would generate exactly the same tax benefits. One might suggest that the lower rates that currently apply to foundations might be the most appropriate. They would be subject to the same distribution requirement and their grants would have to be open to public scrutiny. Equalizing the tax benefits would take away one of the key marketing claims for the superiority of DAFs over foundations. It would also address the warehousing concerns, as well as the lack of transparency. Donors may still opt to open DAFs simply because there would be less demands on their time and resources compared to starting a private foundation. However, the other competitive advantages, no payout requirement and total secrecy, would disappear. 

Some will ask if community foundations should not be treated differently from for-profit sponsors. These institutions are grounded in their local areas and are generally viewed as good without qualification. However, as The New York Times and other publications have pointed out, they are not immune to charges of warehousing money. The Times did an extensive report on Nicholas Woodman, an entrepreneur who gave $500 million to a DAF housed at the Silicon Valley Community Foundation. According to the Times, there was little evidence of any serious giving from the DAF four years after the gift and presumably the receipt of a charitable deduction valued at the appreciated value of the stock that Woodman used in the transaction. Some will claim that this is an isolated case, but there is enough evidence to suggest that community foundations are not necessary more vigilant in encouraging donors to use their money than Fidelity or Schwab.

Second, no administrative costs for foundations or DAFs could be counted towards the distribution requirement. While this proposal goes one up on the ACE Act, it also addresses one of the key flaws in the 1969 Tax Reform Act, which allowed grant-management expenses to count towards a donor’s mandated 5% payout. For foundations, this meant that their management and boards could choose between increasing staff costs or increasing grants to worthy recipients. Many foundations are careful about expenses, but the largest institutions tend to spend 20% or more of their required charitable giving on staff. The Rockefeller Foundation, for example, spent about $93 million on management and $175 million on grants in 2020. In other words, over 30% of its spending went to salaries, travel, and other management costs. For DAFs, a slightly different dynamic exists. Their sponsors make their money as a percentage of the assets under management. Fidelity charges modest fees for management and investment services, but the total could still be close to 2% on accounts where the grantmaking decisions are made by the donor and not staff. Other nonprofit DAF sponsors have higher rates because they often provide additional advice as to where grants should be made. If these expenses are not excluded from the distribution requirement for DAFs, a large chunk of their “charitable giving” might be eaten up by exorbitant fees charged by sponsors.

Third, the distribution requirement for foundations and DAFs would be raised to 10% each year. Since the ACE Act was proposed, public concern about the limited grantmaking of DAFs and foundations has increased. At a time when many of these entities are reaping substantial investment returns, the “burden” of giving away more money each year is not a serious one. For some private foundations, their total grantmaking might rise to 12% because of the prohibition on counting expenses toward the distribution requirement. Would this new requirement mean that some foundations would spend down over time? Yes, but that is a small price to pay for getting more money into the hands of working nonprofits.

Finally, all transfers from private foundations and DAFs to §501(c)(4) groups would be curtailed. The justification for these transfers has always been based on the shaky idea that, as long as the mission of donor coincides with the work of the (c)(4), this money is simply augmenting the donor’s charitable agenda. But it is now clear that many of the largest (c)(4)s are highly politicized in terms of advancing the chances of one candidate in an election or promoting the passage of controversial legislation. If donors want to support this work, they should do so without the tax benefits and advantages that are accrued in giving to foundations and DAFs.

Furthering a true debate

These modest proposals would take the ACE Act one step further. One step may be a step too far in terms of the politics surrounding any changes to the laws governing the charitable sector. A small but influential group of donors, sponsors, and activists has too much at stake in the current system that most objective observers are quick to label as “broken” and “corrupt.” However, as noted earlier, there is a growing discontent with this world and how it operates. The number of critics, from the left and the right, has increased significantly since ACE was introduced and set in motion a true debate about need to clean up philanthropy. These four ideas would begin to address this need by expecting foundations and DAFs to give away their resources to legitimate charities rather than hoarding assets, running up big management expenses, and avoiding public scrutiny.