January 18, 2024

Over our decade-plus of working with community foundations, we have seen many of them allow donor advised fund (DAF) donors to use their personal investment advisor as the advisor of their DAF’s investments. While this practice creates its own administrative burden, community foundations typically view it as a courtesy to the DAF donor. Additionally, a mutually beneficial relationship may develop between the community foundation and the third-party investment advisor: the community foundation gains an “external development team” to help increase the community foundation’s assets under its management, and the investment advisor continues to receive regular fees and influence. This approach has been formalized as a program for third‐party investment managers (TPIMs), and it has led to a paradigm shift in the foundation’s relationship with investment advisors and fundholders.

At the 2023 FAOG Conference in San Diego, Kate McKenzie, Senior Director of Development, and Bradley Jones, Investment Manager of External Portfolios & Impact at The Pittsburgh Foundation, led a session on community foundation relationships with TPIMs. In it, they covered the reasons why The Pittsburgh Foundation decided to actively cultivate relationships with TPIMs and the necessary procedures required to properly manage the program and monitor the TPIMs. The Development and Investment Team members saw value in utilizing such a program, since partnering with a donor’s investment advisor can help the community foundation grow its assets under management by increasing its visibility when the TPIM advises donors on their investment and charitable goals.

Cultivating and Managing the Community Foundation and TPIM Relationship

In order to realize these benefits, the community foundation’s development team must invest time with TPIMs to share the community foundation’s philanthropic benefits. The Pittsburgh Foundation accomplished this by hosting large-scale presentations on the program, conducting one-on-one meetings with advisors, organizing professional advisor committees, and offering continuing education events for lawyers, tax professionals, and financial advisors.

While a relationship formed between the development team and TPIMs is a great start, a formal governing structure of the TPIM program must also be established to safeguard the assets of the community foundation. For The Pittsburgh Foundation, this included an investment policy statement and benchmark, an online due diligence questionnaire, and annual meetings with TPIMs.

The Pittsburgh Foundation team also established a system for collating the investment activity of underlying portfolios managed by the TPIMs. This information is critical for the community foundation’s financial and tax reporting.

In the FAOG presentation, McKenzie and Jones explained that the program utilizes a minimum dollar threshold for investments to be managed by an individual TPIM. This lessens the administrative burden of having multiple investment advisors, which may be a barrier to other community foundations when considering the expanded use of TPIMs. While having such a program requires a considerable time commitment of the development, investment, management, and accounting teams, The Pittsburgh Foundation is convinced the benefits far outweigh costs.

IRS Regulations Concerning Community Foundations and TPIMs

Since attending this presentation, the IRS has issued long-awaited proposed regulations under Code Sec. 4966, which address taxable distributions from DAFs. In addition to guidance on taxable distributions, the proposed regulations contain several definitions – either newly defined terms or more thorough and detailed definitions than what was previously available. Under the proposed regulations, the term “donor advisor” includes a TPIM who manages the personal funds of the donor and the funds held in the donor’s DAF. Since the TPIM is a donor advisor for this purpose, the DAF is prohibited from engaging in transactions with the TPIM, including the payment of investment management fees to the TPIM.

If the DAF does pay fees to a TPIM who is a donor advisor to the DAF, the payment is an excess benefit transaction. The TPIM is subject to a 25% excise tax on the transaction. The sponsoring organization’s management may be assessed a 10% excise tax under certain circumstances. Finally, the transaction must be reversed.

Proposed regulations are not binding, and community foundations are not required to follow the guidance included in proposed documents. When the regulations are finalized, they are generally effective as of the date of finalization, though there are circumstances in which the effective date is different, and Treasury may include grandfather rules in limited circumstances.

The prospect of significant excise taxes on transactions with TPIMs will likely significantly curtail the use of the TPIM structure described above. Although these are proposed regulations, community foundations may want to make plans now to address this change in the event the final regulations mirror the proposed regulations in this respect. Consider the following steps:

  • Ensure new DAF agreements contain language indicating a change in law, guidance, or other rulemaking that affects the operations of the DAF are adopted by the community foundation and the DAF as of the effective date of the item in question.
  • Consider amending existing DAF agreements to contain the language described above as needed and in instances where existing agreements are lacking such language.
  • Communicate with donors regarding the community foundation’s approach and philosophy around applying proposed regulations now versus waiting for final regulations.
  • Coordination with TPIMs to plan for the transition of assets to another advisor in the event such a transition is required.
  • Internal planning for the movement of significant investments to other advisors utilized by the community foundation.

If enacted as written, the regulations will apply to tax years ending after the date the regulations are published. For example, if the regulations are published on December 30, 2024, they are effective for tax years ending December 31, 2024. Using this example, an organization with a December year end would have to comply with the regulations starting January 1, 2024, since the tax year ends on December 31, 2024.

Treasury always seeks comments on proposed regulations. The comment period for these regulations ends February 15, 2024. More information on submitting comments can be found here. If you have questions concerning community foundations, DAFS, and TPIMs, send us an email and we’d be happy to discuss them with you.

© Clark Nuber PS, 2024. All Rights Reserved.

This article contains general information only and should not be construed as accounting, business, financial, investment, legal, tax, or other professional advice or services. Before making any decision or taking any action, you should engage a qualified professional advisor.