Distribution from Donor Advised Fund to Private Foundation

Technically, it is possible, but there would be some significant strings attached.

Distributions from Donor Advised Funds (DAFs) are subject to Internal Revenue Code (IRC) § 4966. That section provides that certain distributions will be subject to excise tax. The tax is imposed at both the organizational level and the management level. The organization that administers the DAF (the
“sponsoring organization”) is subject to tax in an amount equal to 20% of the improper distribution. In addition, the officers and directors (and in some cases, employees) of the sponsoring organization who approved the distribution are jointly and severally liable for a tax equal to 5% of the improper distribution, up to $10,000.

Any distribution from a DAF to a natural person is a taxable distribution. Moreover, any other distribution from a DAF will be taxable (1) if it is for non-charitable purposes or (2) if the sponsoring organization does not exercise expenditure responsibility. However, expenditure responsibility is not required for distributions to other DAFs, to the sponsoring organization, or to organizations described in IRC 170(b)(1)(A) (e.g., public charities).

Expenditure responsibility is a private foundation concept. It means that the donor is responsible for exerting reasonable efforts and establishing adequate procedures to ensure that a distribution is spent solely for the purpose for which made.

Therefore, to avoid excise taxes under IRC § 4966, the sponsoring organization would be required to exercise expenditure responsibility for distributions from a DAF to a private foundation. This would involve:

  1. Conducting a pre-grant inquiry, including a reasonable investigation of the grantee to ensure that the proposed activity is charitable and that the grantee is able to perform the proposed activity.
  2. Executing a written agreement with the grantee that specifies the charitable purposes of the grant and includes provisions that prohibit use of the funds for lobbying activities and require the grantee to return any funds not used for the designated purposes.
  3. Requiring the grantee to maintain the grant funds in a separate fund so that charitable funds are segregated from non-charitable funds.
  4. Requiring the grantee to provide regular reports on the use of the funds and the charitable activity supported by the grant.
  5. Including a report on Form 990-PF about the grant, including a brief description of the grant, the amount, the charitable purpose and the current status of the grant.

This can be a burdensome process for both the donor (the sponsoring organization) and the donee (the private foundation), and these strings would be in effect until the grant is completely exhausted.

Posted by Joel D. Roettger, JD, LLM, EPLS

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