In the first weeks of the coronavirus pandemic’s assault on our nation, donors who hold donor-advised funds have been stepping up in a major way to help support those in need.
DAF grants from the National Philanthropic Trust increased 120 percent in March over the same month in 2019. And for 30 community foundations surveyed by the Community Foundation Public Awareness Initiative, DAF grant making rose by nearly 80 percent in March, with a bigger increase expected for April.
If such trends continue — and I expect they will — we will likely see billions in additional funds moving to nonprofits from DAFs this year.
But even in the face of studies that show DAFs provide a stable lifeline for nonprofits during times of economic trouble — and news that DAF donors have quickly responded to a disaster that will require years of sustained investment — the critics remain out in full force.
The critics are right that DAF sponsors should be encouraging their donors to give more in the face of this crisis. But in suggesting that nothing short of distributing everything in the funds will suffice, some nonprofit observers ignore crucial facts about how DAFs work and the long-term role they play.
Indeed, these funds are routinely labeled “shams” and “tax shelters” where the wealthy stash money for themselves at the expense of charities that will never see the benefit of their largesse. These falsehoods are being spun and recycled in media coverage and in commentary — including articles in the Chronicle — and they could lead to rules that would hurt nonprofits of all sizes.
The simple truth is that DAFs are helping to expand the pie for nonprofits, not shrink it. They make it easy for donors to give, and without them, much less money would make its way to the homeless shelters, soup kitchens, and environmental charities that are presented as victims in most commentary about DAFs. Nonprofits received more than $23 billion in grants from DAFs in 2018 — and that figure has shot up for the better part of the last decade.
But if the critics get their way, forcing DAFs to have a payout over a certain number of years or arbitrarily restricting the types of grants DAFs can make or deferring charitable deductions or pushing for fund-by-fund accounting as an effort in California would require — the ironic result would be that grants from these vehicles would likely fall, not rise. And during times of crisis, many nonprofits would likely lose a critical lifeline.
Community Foundation Creation
While media accounts would lead you to believe that they are a gimmick cooked up by Silicon Valley tech wizards, DAFs were created by community foundations nearly 100 years ago. Their rising popularity — particularly when used at community foundations — is a sign that more Americans are interested in being strategic with their philanthropy.
DAF advisers want to help their communities, work with other donors to tackle persistent problems, and get their children involved in a lifetime of giving. In fact, money contributed to DAFs is granted out at a much faster rate than money that is invested in private foundations and other philanthropic vehicles. According to the National Philanthropic Trust, the average payout rate is around 20 percent, or four times the required payout from foundations.
Yet the critics want you to believe that donors are not really making gifts to begin with. This is because charities that sponsor DAFs usually follow the donors’ recommendations in choosing the ultimate recipients. One writer refers to this as “functional control,” and another prefers “de facto control.”
But there is no such retained control. The money no longer belongs to the donor, and once he or she places money in a DAF, it can be given only to a charity. The law is crystal clear that the charity maintaining the DAFs has exclusive legal control over the assets. Any investment gains on the amounts not granted in a given year do not generate new tax deductions, but they do allow total giving to often exceed the amount of the original gift.
DAF critics would say that the time lag between the gift to a DAF and the eventual grant to a charity is a problem, but every endowment operates this way. And the argument presumes that every charitable gift should be made directly to an end-use charity. As a matter of law, that has never been the case.
Federal tax law expressly recognizes the “indirect public contribution,” such as where one public charity makes a grant to another public charity. Similar timelines exist in connection with private foundations, supporting organizations, endowments, and charitable remainder trusts. Shall we get rid of them, too? What’s more, if the taxpayer chooses to make the $100,000 gift to the end-use charity, the charity might also add that gift to its own endowment and not “spend” the funds that year.
Floors Become Ceilings
The solution to this perceived problem is the regulators’ dream — the mandatory payout.
Mandatory payouts — such as the 5 percent payout rule for private foundations — are artificial constructs, and those floors often become ceilings. Most foundations tightly manage their spending to ensure that they pay out exactly 5 percent of their assets every year, including administrative expenses. Take a DAF sponsor with an average payout of 20 percent across all its individual funds, apply a 5 percent payout by fund, and lots of individual DAF advisers will start granting 5 percent instead of 20 (or more). It seems silly to drive total grant making down to ensure each DAF is making grants regularly. The solution should be to ensure fund activity, and most major DAF sponsors do so.
Another favorite change pushed by DAF critics is the timed payout, which would require all DAF contributions to be paid out over a certain number of years. But timed payouts run counter to the very purpose of DAFs — to provide a vehicle for building an endowment that will help support communities for generations. How can a community build an endowment for the future if all DAF contributions must be paid out over five or seven years? What about a family that wants to get their children involved in philanthropy but doesn’t have the resources to start a private foundation (the average DAF holds less than $200,000 in assets) or wants to save on administrative expenses?
Critics will say that the way around this is simply to have the final payout of the DAF go to the unrestricted fund at the DAF sponsor. But why should donors give up the flexibility to influence the charities that ultimately benefit from their generosity?
Some critics want to defer tax deductions for gifts to donor-advised funds to the time when a grant is made from a DAF to a charity. But such a drastic change would probably wreck DAFs. (Perhaps that is the goal.) Again, critics don’t suggest this approach for gifts to private foundations, endowments, and charitable trusts — all of which are granting money at a much slower rate than DAFs. So why pick on donor-advised funds?
Regulation at the Expense of Respect
Much of the recent criticism about the growth of donor-advised funds centers on the fact that the largest are managed as charitable arms of financial companies like Fidelity Investments or Charles Schwab.
But DAFs are also widely used by community foundations, and many other single-issue or national charities have instituted DAF programs to attract donors. DAFs are critical in fostering philanthropy for subsequent generations. Most importantly, DAFs are attracting gifts from the middle class that would not otherwise be made. Critics also ignore the concept of the “endowed” DAF, an individual legal arrangement under state law that cannot be spent down in a certain number of years. Ignoring all these real-world truisms, the critics prefer more laws and regulation at the expense of respect for donor intent.
We are facing an era of a potential decline in charitable giving because of recent legislation, such as the doubling of the standard deduction and changes to the estate tax. The economic tsunami caused by Covid-19 will only make that decline worse. This is happening at the same time governments are shifting responsibility for the public safety net increasingly to charity and philanthropy.
In response, we need vehicles that expand and enhance philanthropy, and DAFs are part of the solution. Rather than demonizing them, we should be encouraging their growth because ultimately, they are strengthening a fragile safety net. They should be protected and celebrated, not pummeled and criticized.