Filed under: Not-for-Profits

By Sarah Gustafson, CPA, MBT

Billions of dollars will pour into donor advised funds (DAFs) during 2015. Millions of those dollars will flow out to not-for-profits. Could any of that money flow to your organization? How should your organization handle donations from DAFs?

Here’s a tale of an organization – a fictional public charity – that shows how DAFs work from the recipient charity’s perspective.

Doug’s dilemma

Let’s meet Mr. Douglas Fir, the intrepid controller of CascadeKids. Doug is reviewing the month’s revenue records when he spots a check for $10,000.  The check comes from the “Queenie Jones Donor Advised Fund” at NewTown Bank Charitable Fund (NTBCF). Doug knows Queenie – she’s a wonderful new donor. But, Doug’s not familiar with the donor advised fund shown on the check.

“Queenie made a personal pledge of $10,000 to us last month. Could this new donor advised fund check be related to Queenie’s pledge?” asks Doug. “What should I do before cashing the check?”

What’s a donor advised fund anyway?

“First, let’s go over the basics on donor advised funds,” thinks Doug. His research reveals the following:

  • Donor advised funds are special accounts established by donors, but owned and controlled by public charities.
  • A donor advised fund is born when a donor makes a specific grant to a public charity. (The public charity that holds the funds is called a “sponsoring organization.”) After receiving the funds, the sponsoring organization sets up an account separately identified by reference to the donor. Later, the donor can advise the sponsoring organization how to spend or invest the money.
  • Examples of sponsoring organizations include many community foundations, other charitable foundations, and some financial institutions.
  • With a donor advised fund, donors can qualify for a charitable deduction immediately and recommend distributions to charitable recipients over time. It’s important to note that the sponsoring organization makes the final decision about which organization will receive funds from the donor advised fund. The donor can advise only. Although the sponsoring organization does not have to do what the donor asks, it is unusual for a sponsoring organization to deny the advice of a donor advisor if the recipient charity is a federally recognized public charity.

“Donor advised funds sound great,” muses our hero Doug.  “But there’s got to be a catch here. What does the IRS say?”

Pledges and penalties: What recipient charities should know.

Doug is absolutely correct here. The IRS has important rules on donor advised funds that recipient charities need to know. Our hero reads on:

  • If a donor recommends a donation from a donor advised fund, they can’t receive any benefits such as gala tickets or museum admissions as a return benefit.
  • Moreover, donors cannot fulfill personal pledges by using a grant from donor advised funds.
  • If a donor breaks either of these “no private benefit” rules, they need to reverse the transaction that resulted in the private benefit AND pay a 125% penalty on the value of the prohibited benefit.

“Wowsers!” thinks Doug. “Queenie pledged to send us $10,000. Let’s make sure that this donor advised fund check isn’t related to her pledge. Not only could we lose the grant itself, but Queenie would need to pay $12,500 straight to the IRS.”

Straightaway, Doug calls Queenie. “Hi Queenie – we’re really excited to receive this check from your donor advised fund. We just wanted to make sure it isn’t related to the pledge you made earlier this year.”

Queenie clarifies that she originally meant for the check to be a fulfillment of her earlier pledge and asks if that is a problem.  Doug explains the situation and the potential penalties that would arise if CascadeKids were to cash the check in satisfaction of a personal pledge.  Queenie thanks Doug profusely for looking out for her interests and together Doug and Queenie work to properly handle Queenie’s pledge. First, Doug declines to accept the $10,000 check from Queenie’s donor advised fund; instead, he sends the check straight back to the fund. Then, Queenie takes out her own personal checkbook. She writes CascadeKids a $10,000 check to satisfy her earlier personal pledge. “Now that’s a check we can cash!” thinks Doug.

With pledge and checks now in order, Doug and Queenie both breathe a sigh of relief.  Doug thanks Queenie for her generosity and patience.  Queenie, knowing that Doug and CascadeKids know how to look out for their donors as well as their mission, decides to advise many future distributions out of her donor advised fund to CascadeKids.

How to help donors with DAFs

One year later, it’s time for CascadeKids’ annual fundraising gala. CascadeKids knows it might receive more grants from donor advised funds. So Doug creates new contribution envelopes to help clarify the situation for donors:

Yes! I’ll contribute to CascadeKids:
  __ Enclosed $_______
__ Pledge of $_______
  __ Please contact me about planned giving options
  __I’ll recommend my Donor Advised Fund to contribute $_____
  Donor Advised Fund Name: ______________________________

The next day, Doug opens up the envelopes. One of the envelopes contains a beautiful handwritten note from Queenie:

“You guys are great both in the work you do and the care with which you treat your donors. I can’t promise anything, of course, but I’ve recommended that my donor advised fund send CascadeKids $100,000.” – Queenie Jones

“That’s awesome of Queenie. I’ll make a note that we won’t record this as a pledge,” says Doug to himself. “Thank goodness I read up on donor advised funds and I now know that Queenie cannot promise that the donor advised fund will follow her recommendation!”

Note: If you are a donor with a DAF, or a charity that receives contributions from a DAF, or a charity that has been approached by a donor to sponsor his or her DAF, please consult with your tax advisor to make sure you understand the rules and how to handle the situation properly.  

The 5 Ws of DAFs

Why do people donate to DAFs?

  • For many donors, a donor advised fund is a middle ground between contributing to a charity and setting up a private foundation that only plans to donate to domestic public charities. With a DAF, donors can avoid the administrative overhead of private foundations and also keep their donations anonymous.

Who is most likely to make a DAF donation?

  • People for whom time is of the essence. When the year-end rolls around, many people want to reduce their taxable income via charitable giving – but they don’t know quite yet which organization to support! By giving to a DAF, however, donors can take their time to choose potential recipients.

What is the difference between a DAF and a donor restricted fund?

  • “Donor restricted funds” consist of money given to a charity for a specific purpose or for use at some future point in time. These grants are called “restricted” because the donor places certain parameters on how or when the money may be used. When a charity accepts donor restricted funds, it becomes legally obligated to spend (or not spend) the funds according to the donor’s express wishes. For example, a donor might require the recipient to set aside the grant as an endowment, a “permanently restricted fund” which is invested and only the investment income is used for the charity’s exempt purposes. Or, the donor may require that the recipient spend the money only on scholarships — an example of a “temporarily restricted fund.”

When should I cash a check from a DAF?

  • Only after cross-checking your records to ensure that the check does not relate to a prior personal pledge from any donor.

Where do DAFs keep their application materials? My charity wants to apply for funds!

  • Most DAFs don’t have a traditional application for not-for-profits seeking funds, since the process is donor driven. With that in mind, sponsoring organizations’ websites may provide tools that charities can use to reach out to potential donors, such as DAF consideration request forms and charity profiles. Still, the best way to develop donors is through personal relationships and taking care of your past donors. Happy donors tend to tell their friends about heroes like Doug.

Posted by: Sarah Gustafson, CPA, MBT

Sarah Gustafson is a Tax Senior at Clark Nuber. Contact Sarah.

© Clark Nuber PS, 2015.  All Rights Reserved

This article or blog 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.