Non-Profit Legal Recap (June 2021): THE ACE Act and the Court
I will not pretend to be the most diligent follower of legislative developments and Supreme Court cases. It is important, no doubt, but I excuse myself based on my limited reserve of emotional energy to allocate to disappointment. It probably never has been, but the current state of affairs is not a source of inspiration. No award-winning musicals will be made of one Senator’s quest to save the filibuster at the apparent expense of democracy (though admittedly “Manchin!” sounds like a more interesting writing project than this blog). There will be no prestige historical drama about the conquest of the American judiciary by the Federalist Society.
But as the keeper of a non-profit legal blog, I have an obligation to briefly (and perhaps cynically) address two big developments from the past month: The ACE Act and Americans for Prosperity Foundation v. Bonta.
The Accelerating Charitable Efforts (ACE) Act
Let us start with the ACE Act. The ACE Act is proposed legislation and, as such, we should start with the qualifier that there is a very good chance it will never come to pass, at least in its current form. But, donor-advised funds (DAFs) and the extent to which they are soaking up charitable contributions are the elephant in the room of philanthropy. Except that, unlike in that saying, everyone is talking about the elephant in the non-profit sector constantly. We are just not doing anything about it.
For one, there are a lot of (powerful) people and organizations who like the elephant. They would say that because of DAFs having a lower barrier of entry and cost of administration than a private foundation and because they are being managed prudently by institutional investors, more money is flowing into the charitable sector. More inflow + lower administrative expenses = more outflow = more charity. Those supporters of the current DAF regime might say that those positives outweigh the critiques of DAFs (e.g., no spending requirement so donors can get deductions but not be under pressure to actually give; lack of transparency, their use by private foundations to satisfy their minimum spending requirement). Proponents of the ACE Act would probably say “No, they do not outweigh them, and here are some more bad things about the current state of DAFs…”
My personal take on the above argument is: I have no idea. We collect so little information from DAFs that is hard to know whether the impact is a net good or a net harm. Or whether the potential abuses or failure of DAFs to actually give are happening often or not (though based on one recent study, someone might just respond that I’m not looking hard enough). I am also pessimistic that a shift of DAF resources to the public charities the wealthy would likely make their large gifts to instead (i.e. not the under-resourced ones serving needy) or private family foundations (more highly regulated in theory, but in practice?) is unlikely to have the impact on the most vulnerable that the bill’s advocates suggest. But, deep down, I think most of us who work in the non-profit legal sector know that the DAF regime is far from well-calibrated to deliver charitable impact and I admire those (a lot of credit to Ray Madoff for driving the underlying proposals for years) who are trying to make something happen with the hundreds of billions dollars at stake.
In any event, people are worked up about DAFs, there is now a bill that proposes a fairly broad reform of the DAF regime, and it has gotten more attention/support than some of us might have guessed. So what would it do?
More Categories! The act would create new categories of DAFs:
Qualified DAFs: A qualified DAF is a fund that is required to ‘terminate advisory privileges’ as to contributions after 14-15 years (let’s call it 15 years). To claim a charitable contribution to a DAF, a donor will need to identify a preferred recipient at the end of the 15 years in the event they have not advised sufficient distributions. The remaining amount of the contribution and the income on that contribution would presumably then be re-distributed to that organization if the donor-advisor had not gotten around to advising different grants. While these might sound like time-limited DAFs, my read and understanding is that the DAFs can go on for longer than 15 years, they just need to make sure that any particular contribution is re-distributed within 15 years.
Qualified Community Foundation DAFs: This category provides more favorable treatment to certain DAFs at community foundations with substantial assets (at least 25% of assets) outside of donor-advised funds. Community foundations are public charities sponsoring DAFs that are serving a particular geographic area (consider whether the ‘commercial DAFs’ will start multiplying to have region-specific public charity DAF sponsors to take advantage of this requirement, though getting to 25% is non-DAFs might be a challenge). To get the preferential treatment, the DAF needs to be either (1) subject to an annual 5% minimum distribution requirement, or (2) less than $1M in size.
Non-Qualified DAFs: If you are not one of the “good” categories of DAFs, then you are a Non-Qualified DAF. Donors do not receive any deduction for a contribution a Non-Qualified DAF until and to the extent that the contribution is re-granted to a non-DAF charity. If this all comes to pass, one thing I am curious about: will donors committed to warehousing still give to Non-Qualified DAFs? I do not see anything in this bill that eliminates the fact that, just by giving to a Non-Qualified DAF (like a gift to any charity or foundation or tax-exempt entity), the appreciated gain on the donated asset is shifted to a tax-exempt entity. That tax benefit is what drives a lot of charitable giving. Now there are other ways to achieve that than DAFs and no one wants to give up a deduction for no reason, but seems possible to me that they will still find some usage.
Excise Taxes! The sponsoring organization will pay (out of the DAF) a 50% excise tax on contributions that are not timely distributed. For qualified DAFs, that means a 50% tax for contributions (and the allocable income) that have not been distributed after ~15 years. For Non-Qualified DAFs, that means a 50% tax for contributions (and the allocable income) that have not been distributed after ~50 years. Qualified Community Foundation DAFs are not subject to either requirement.
Limits on Donation of Non-Publicly Traded Assets! Even for the “good DAF” categories, if the donated asset is not cash or publicly traded stock, then (1) there is no deduction until the asset is sold and (2) the contribution is limited to the sale proceeds of that asset credited to the DAF. Donors would still get to contribute these assets, but they no longer to participate in one of the more criticized (but also popular) aspects of DAFs: the ability to give and get a charitable contribution deduction for an illiquid asset now, even though that asset might not take the form of cash useable by a public charity any time in the near future (or, when it does, end up resulting in a lot less cash because it was sold for less than appraised by the donor).
Changes to Public Support Treatment of Grants from DAFs. Long on the radar of IRS and now apparently Congress, the ACE Act introduces a rule that contributions from a DAF are not counted as public support. That means that an individual can no longer use a DAF to fund an organization that only they support and maintain public charity status for an organization that would otherwise be a private foundation. How much was this happening? Who knows — more than ‘not at all’ but less than ‘all the time’ — but it is hard to argue with the common sense of the rule.
More Private Foundation Rules About DAFs! Another long-threatened rule, the ACE Act would stop private foundations from counting grants to a DAF towards their minimum distribution requirement. Many understandably considered this practice a work-around for the minimum distribution requirement since a foundation could theoretically satisfy its minimum distribution grant by just adding to their DAF which, at least until the ACE Act or other legislation is passed, has no minimum requirement. In practice, while that is almost certainly happening to some extent, my guess is that foundations utilizing DAFs are often doing so for the anonymity that grants from DAFs provide (i.e. granting to an organization they do not want it publicly known they support by granting to a DAF and having that DAF re-grant to the other organizations). Foundations could still make grants through their DAFs in situations where they want their support to be anonymized, it just would not count towards the 5% requirement.
More Private Foundation Rules About Other Stuff! Only a couple years after (finally) simplifying the net investment income tax provision so that is a simple 1.39% of investment income tax, the ACE Act proposes two exemptions from the tax for private foundations that are either of a limited duration or over-spend their minimum distribution requirement (7% instead of 5%). The ACE Act also adds a result that prohibits foundations from counting compensation to substantial contributors and their family members towards their minimum distribution requirement. For large foundations, this is probably not a big issue — the family is generally too wealthy to be taking compensation from the foundation anyway. But I have often wondered how many $1M foundations are out there paying the children $50k to run the foundation and satisfying the minimum spend requirement on that alone. This rule would take that option away and it is hard to see that as a bad thing.
And, for now, we wait. Even if not passed imminently (and that seems unlikely that it would be), my experience is that these provisions bubble back up and find their way into some budget (or pandemic relief) bill or another. So even if the ACE Act is not approved in whole, we at least have a more educated guess about what the future of DAFs might look like.
Americans for Prosperity Foundation v. Bonta
In this case, the Supreme Court…..[author reviews coverage is reminded of the further destruction of the Voting Rights Act in Brnovich v. Democratic National Committee; tries to focus back on the Bonta decision and gets too discouraged about the state of judicial affairs to write].
Sorry, I can’t do it.
Let’s just leave it at: the Supreme Court struck down California’s long-standing requirement that charities attach the (not available to the public) Schedule B of the Form 990 to their annual submission of the 990 which lists the donors who contributed more than $5k. This is apparently unconstitutional now. Read smarter people than me on this case: Nina Totenberg for NPR and Amy Howe from SCOTUSBlog.
Practically, the immediate impact may be small (a couple fewer pages going to the AG on the RRF-1 each year) but the exacting scrutiny test now being applied to disclosure rules means that more changes may follow in the coming years. For any individual non-profit, less regulation may seem like a positive. But for a sector already facing criticism for a lack of transparency, and coming off a prior administration that did away with 501(c)(4) donor disclosure to the IRS entirely, the “this is all unaccountable dark money” drumbeat is only going to get louder. Some would argue that all non-profits depend on the reputation of the sector as a whole, which requires transparency and effective regulation. That goal will be harder to achieve in the future.
