Support Grows for Adoption of New Federal Rules on Donor-Advised Funds

Donor-advised funds have become one of the nation’s most popular giving techniques.

And yet the funds operate with few clear legal guidelines.

But that may soon change. Officials in Washington have begun considering how best to regulate the funds, which allow donors to obtain a tax deduction on gifts to a community foundation or similar charity, then recommend how to distribute the money.

In February, the Clinton administration asked Congress to pass new rules on donor-advised funds. The restrictions it proposed would require such funds to distribute a minimum portion of their assets each year to charity and discourage donors from recommending inappropriate uses for their money.

Helping to fuel the drive for new legislation is the concern that some organizations are allowing or encouraging people to make grants from their donor-advised accounts to themselves or to groups that provide personal benefits to the donors.

In an analysis of the proposed regulations, which are outlined in President Clinton’s 2001 budget proposal, the Treasury Department said that new laws are needed “to encourage the continued growth of donor-advised funds” while also “minimizing the potential for misuse” of the funds.

Donor-advised funds are offered by community foundations, Jewish federations, and other charitable organizations, including non-profit corporations formed by commercial banks and brokerages. Donors who establish such funds get an immediate income-tax deduction for an irrevocable gift of cash or some other asset. They then can recommend how and when grants will be paid from the funds to charities.

Under the Clinton administration’s proposal, organizations that offer donor-advised funds could incur stiff penalties if they fail to meet three main requirements:

* The organizations must maintain control over how the money in the gift funds is spent. Donors can only recommend — not dictate — which groups receive grants from their accounts.

* Grants made by the funds must go only to charities, private operating foundations, or some government-related groups.

* The annual grant payout must equal or exceed 5 percent of the aggregate assets of the funds that the organization maintains, the same payout threshold that applies to private foundations.

Penalties for breaking one of the rules would be stiff. A charity that maintained more than half of its assets in gift funds would risk being classified as a private foundation if it violated one or more of the rules. Private foundations are subject to far stricter regulations than are charities, including the imposition of an excise tax on their investment income and lower deductibility limits for donors’ gifts.

A charity that maintained less than half of its assets in donor-advised funds would not be subject to private-foundation rules, but the portion of its assets that were held in donor-advised funds could be.

The proposed rules also would penalize donors who recommended that distributions from their funds be used in ways that provided personal benefits.

Legal experts and officials at many gift funds have long argued that if action isn’t taken to prevent abuses of donor-advised funds, Congress or the Internal Revenue Service could wind up imposing far stricter regulations that would slow or even stop the growth of the technique.

“We’re in favor of anything that would give people a more secure feeling about donor-advised funds and that would put all the funds on a level playing field,” says Susan Smith, marketing director for the Vanguard Charitable Endowment Program, a donor-advised fund offered by the Vanguard Group, a brokerage company.

Still, consensus does not yet exist among charity officials on exactly what form new legislation should take or whether the administration’s proposal, as currently crafted, would lead to unintended problems.

Concern exists, for example, that the proposed rules could stop grants from being used for gifts to foreign charities. Barring donor-advised funds from making overseas grants is a particularly nettlesome issue for many non-profit groups.

“In a global economy, this creates a very xenophobic approach to philanthropy,” says Drummond Pike, president of the Tides Foundation, a charity in San Francisco that has about 250 donor-advised funds with $124-million in assets.

Tides makes grants to overseas charities and is helping to start a sister organization in Canada that Mr. Pike says will probably receive grants from Tides — unless Congress winds up preventing such transactions.

Some observers also worry that the rules, as currently proposed, could impose penalties on a charity even if only a single gift-fund account were used inappropriately. Phasing in penalties and shifting some of the burden of compliance to donors — and away from charities — would make the rules more equitable, they say.