DAF Battle Continues on Capitol Hill

In May, fourteen Republican state attorneys published an open letter opposing a piece of legislation known as the Accelerating Charitable Efforts Act, or ACE Act. The letter was the latest exchange in a political debate over the function and workings of donor-advised funds. Proponents of the ACE Act say it will make donor-advised funds (DAFs) operate as intended, while critics say the legislation aims to fix a problem that doesn't exist. The bill was introduced in the Senate in June 2021, and in the House this February, but currently looks unlikely to be passed. However, the public perception battle over what the bill represents—tightened regulations on economic elites—is far from dead.

Commercial DAFs are run by nonprofit arms of national financial services firms. These firms allow a donor to create an account from which to make charitable contributions, influence or determine to which causes capital is distributed over time, while the federal government offers immediate tax deductions for the assets placed in the account. But there's no requirement for the DAF to immediately funnel money on to charities, and because this prospective giving is deferred, the contents of the accounts can be invested and grown, which means more cash can later be paid out. With the combination of maximized giving and immediate tax breaks it's easy to see why DAFs are attractive to donors.

In a 2019 interview, Houston-based billionaire John Arnold used the phrase, “giving from beyond the grave” when talking about DAFs. This too, is attractive to the donors, the ability to give in perpetuity, having an effect upon society after death. In some cases, funds are posthumously folded into the unrestricted endowment of the financial firm that has managed the DAF, but legal agreements or wills can specify other actions, including passing along the DAF's advisory role to the donor's children. It's important to remember that donors cannot reap tax benefits unless making a “completed gift,” which is to say, relinquishing legal control over the funds. In practice, though, DAF managers rarely go against the wishes of advisors. Disagreements tend to result in lawsuits.

DAFs were created in the 1930s but didn't begin to grow in popularity until the 1990s, as the knowledge of them as a charitable giving option spread, and fee-seeking financial firms increasingly prioritized their creation. Today they're by far the fastest growing philanthropic vehicles, having doubled in number from 2017 to 2018 alone thanks to the Tax Cuts and Jobs Act, which advantageously changed the individual tax deduction for people who put money into the accounts. Today there are more than one million DAF accounts in the U.S. While one can be started with as little as $5,000, leading some to label it a giving vehicle for the middle class, in reality the average seed amount is $162,000.

These divergent figures—both factual—typify the DAF debate. On one side are advocates who tout what DAFs can be at their most egalitarian, versus those on the other side who point out how they actually tend to be used. For example, advocates say that DAFs can ramp up giving in times of crisis, making them, in effect, rainy day funds, however research by the Donor-Advised Fund Research Collaborative found that between 2017 and 2020—one of the more turbulent periods in American history—29% of DAFs didn't make a grant in a typical year, and 35% paid out less than 5% of their assets.

In fairness, the picture isn't complete without noting that the same research found that “about 42% of the DAFs that opened in 2017 had granted out their entire opening contribution by the end of 2020, and another 22% had granted at least half.” Nevertheless, the DAF debate hinges on real and serious problems of non-disbursal. While advocates point at the higher payout rates of DAFs, a percentage of that money doesn't go directly to charity. One analysis from last year showed that in 2019 more than a billion dollars donated by DAFs went to other DAFs, and that this circular practice may be growing by 50% per year.

Another trend not usually commented upon is the flow of money from private foundations to DAFs. A March study by Inequality.org found that in 2018 alone, private foundations gave $740 million to DAFs. This money is allowed to count toward a private foundation's yearly charitable distribution requirement, a practice that effectively circumvents regulations enacted to ensure that private foundations earn their tax-free status by shifting money into the public sphere.

In addition, many critics note that because the tax breaks received by DAF donors must be subsidized by taxpayers, donors are rewarded for giving that doesn't occur. It can be considered a question of simple fairness because the subsidies involved are so huge. According to Inequality.org, for every dollar a billionaire gives to charity, taxpayers must chip in up to 74 cents to cover the revenue lost from tax breaks.

The ACE Act was written with the goal of spurring DAFs to distribute cash to charities more quickly than at present. Among its many provisions: it would deny an immediate tax deduction when all of a DAF's assets aren't distributed within fifteen years; it would deny tax deductions for gifts of non-publicly traded assets until the DAF sold them; and it would require larger DAF accounts to distribute at least 5% of its funds annually, with this last clause sparing DAF accounts set up by actual middle-class donors.

The letter signed by the Republican state attorneys describes the ACE Act's goals as laudable, but says that its restrictions would likely have the opposite intended effect and discourage charitable giving. Part of the rationale for this conclusion has to do with the Act's rules around privacy. Some wealthy people have shifted their giving to DAFs because the donations aren't publicly reported. Provisions in the ACE Act would tweak disclosure rules. The state attorneys make clear in their letter what usually goes unspoken—that many wealthy donors give massive sums not to those in need, but, “to influence public policy.” In this era of voter concern about dark money and the unequal power of lobbyists, and in a country ranked by the Tax Justice Network as number one in the world for financial secrecy, it's no wonder new disclosure rules are a worry for some wealthy people.

The money stockpiled in DAFs is now estimated at up to $160 billion, though their rapid growth over the last ten years of 376%—and accelerating—makes estimates obsolete within months. Nearly every advocate of DAFs agrees in public that philanthropic goals rather than the pursuit of financial advantage is their purpose, but it should be clear enough by now that the growth of these funds is largely driven by something other than the desire to do good works. More than 80% of the assets in DAFs remain undistributed during our current time of tremendous need, though the tax breaks on that capital have been conferred to donors.

The complexities of the issue are manifold, far more than can be clarified in an article, but even though the initial furor over the ACE Act has quieted a bit, discussion about donor-advised funds' ultimate purpose and form is crucially important. Financial instruments nearly always seem unambiguous and airtight to their designers, but any system can be hacked. It just takes a loophole and the will. As a speaker at a digital security seminar I attended years ago put it: “A building that has bars over nine out of ten windows doesn't stop 90% of thieves; 90% of thieves find the open window.” Anything created nearly a century ago, as DAFs were, will have failed to anticipate modern fiscal, political, and social realities. The current debate is probably long overdue.