The Accelerating Charitable Efforts (ACE) Act

The Accelerating Charitable Efforts (“ACE”) Act introduced into Congress proposes several changes to the tax consequences of donor-advised funds (“DAFs”).

DAF Background

DAFs are accounts maintained by sponsoring organizations allowing taxpayers to make contributions intended for current and future charitable giving.  Taxpayers may make cash or noncash contributions to a DAF and receive a charitable deduction during the year of contribution.  However, it may be decades before the sponsoring organization makes a distribution, known as a grant, to an IRC Sec. 501(c)(3) charity or other qualifying organization.  While the donor cannot control the funds after contribution, donors often make non-binding recommendations on timing, amounts, and recipients of the grants.

There has been a dramatic increase in taxpayers’ use of DAFs.  For example, as reported in the National Philanthropic Trust’s 2022 DAF Report, contributions to DAFs in 2021 totaled $72.67 billion, an all-time high, and a nearly 47% increase in contributions from 2020.  Additionally, total grants from DAFs in 2021 totaled $45.74 billion, over a 28% increase over grants made in 2020.  There are several methods used to calculate the grant payout rate for DAFs.  The average of the four most commonly used formulas was 25.5% for 2021.  Therefore, nearly 75% of total DAF assets were maintained in the accounts and not distributed out to IRC Sec. 501(c)(3) charities and other qualifying organizations.

During the COVID pandemic, many charities and other nonprofit organizations struggled to support their communities.  This observation prompted philanthropists, politicians, and legal researchers to become concerned by the delay in donation to a DAF and the eventual receipt of funds by a charitable organization.  In response, the ACE Act was introduced into Congress as S. 1981 and H.R. 6595. 

The ACE Act

The ACE Act is aimed at achieving two goals: (1) the mismatch in timing between when the taxpayer receives a tax deduction for a DAF contribution and when the charitable organization receives the funds and (2) limiting perceived perpetual donor control.

1.  Mismatch in Timing:

The ACE Act would impose three general rules regarding the timing of deductions:

1. Tax deductions for noncash contributions to a DAF (example: real property, closely held business interests, etc.), would be disallowed unless the property is later sold for cash.
2. Tax deductions would only be allowed in the year the DAF makes a cash grant to a charitable organization.
3. The amount of the tax deduction would be limited to the amount of the qualifying distribution.

The ACE Act would establish two new types of qualified DAFs that would not be subject to these rules: a qualified donor-advised fund (“QDAF”) and a qualified community foundation donor-advised fund (“QCF-DAF”).   These qualified DAFs would still allow a tax deduction in the year of initial contribution to the DAF.  However, a taxpayer contributing an asset other than cash or publicly traded securities to a QDAF or QCF-DAF would not receive the tax deduction until the year the DAF sells the asset and receives cash.

QDAF:

Upon contribution, the donor would have to designate a “preferred organization” to receive the contribution and earnings thereon.  The QDAF would then be required to make the grant within 14 years of the contribution.  If the QDAF fails to distribute the contribution (and earnings), it would face an excise tax equal to 50% of the undistributed amount. 

QCF-DAF:

A QCF-DAF would be a DAF maintained by a qualified community foundation, recognized as an IRC Sec. 501(c)(3) organization that is operated for the purpose of serving the needs of a particular geographic community. A QCF-DAF would limit DAFs to a maximum asset value of $1 million, or requires at least 5% of the DAF’s value to be distributed in each calendar year. 

2.  Perpetual Control:

The ACE Act would require all contributions to DAFs to be distributed within 50 years of contributions.  Distributions would be considered made first from the earliest contributions to the DAF.  Failure to distribute the funds within 50 years would result in a 50% excise tax on the undistributed amount.

Observations

The ACE Act, if passed, will have a wide range of possible effects on charitable giving.  Some donors appreciate making donations to DAFs as a streamlined vehicle for achieving their philanthropic goals.  These donors may not be motivated by the timing of the resulting tax deduction.  For them, their giving will remain unchanged. 

However, other donors purposely time their DAF contributions to occur in years when their tax liability will be highest.  These donors might also purposely make non-cash contributions of highly appreciated assets, rather than cash, to avoid tax on capital gains.  It is reasonable to anticipate that there will be a large influx in the creation of DAFs in 2022 in an attempt to be grandfathered into the current timing rules.

Finally, some DAF donors are attracted to the ability to preserve assets in the account, in perpetuity.  These donors may be concerned about providing for a favored charitable organization’s future needs.  Additionally, these donors may want to pass the DAF onto future generations as a way to instill the values of charitable giving onto their children and grandchildren.  In light of possible new restrictions imposed by the ACE Act, these donors may look to other investment vehicles, such as private foundations, to carry out their philanthropic goals.

Our Current Issue Q4 2022:

• Tax Court Ruling Establishes Oversight of IRS Administrative Settlement Programs
• The Accelerating Charitable Efforts (ACE) Act
• Tax Consequences Related to COVID-19 EIDL Loan Default and How to Mitigate Them
• Will 2023 Bring Clarity to These Leading IRS Issues?