On March 9, 2023, alongside President Biden’s release of the proposed fiscal year 2024 budget, the U.S. Department of the Treasury (“Treasury”) released the General Explanations of the Administration’s Fiscal Year 2024 Revenue Proposals (the “Green Book”).[1] The Green Book describes two proposals related to the payout rules applicable to private non-operating foundations. Under the proposals, neither (i) distributions by a private foundation to donor advised funds (“DAFs”) nor (ii) certain payments by a private foundation to disqualified persons (“DQPs”) would count for purposes of meeting the private foundation’s minimum payout requirement. The Green Book indicates that these proposals are intended to address the Administration’s concern that private foundation grants to DAFs and payments to family member DQPs may potentially subvert the intent of the private foundation payout requirements, which is to ensure that private foundation assets are applied to the carrying out of charitable purposes.
Background
Under section 4942 of the Internal Revenue Code of 1986, as amended (the “Code”), a private non-operating foundation is required to annually spend or distribute a minimum amount in furtherance of its charitable purposes in order to avoid penalty excise taxes. The minimum distributable amount generally is equal to 5 percent of the net fair market value of the private foundation’s non-charitable assets, and must be paid out in “qualifying distributions.” Qualifying distributions generally include grants to public charities and private operating foundations that are not controlled by the private foundation and the private foundation’s own direct charitable expenditures, including reasonable administrative expenses and acquisition costs of assets used for charitable purposes. A grant to a controlled organization or to a private non-operating foundation will also be treated as a qualifying distribution if the grantee makes a distribution equal to the total amount of the grant in the next taxable year and that distribution is a qualifying distribution that is (or would be if the grantee organization was a private non-operating foundation) treated as a distribution out of corpus and the private foundation obtains sufficient evidence of the distribution. The current rules do not distinguish among types of non-controlled public charity grantees or among payees of reasonable administrative expenses. A private foundation that fails to make qualifying distributions equal to its minimum distributable amount in a timely manner is subject to excise taxes on its undistributed income.
Proposal for Treatment of Grants to DAFs
Under current law, grants by a private foundation to a DAF are generally considered qualifying distributions. A DAF is a fund or account maintained at and owned by a public charity sponsoring organization. Accordingly, grants to a DAF are grants to a public charity and are generally qualifying distributions.
The proposal would exclude from treatment as a qualifying distribution any grant by a private foundation to a DAF unless (i) the funds are expended by the DAF as a qualifying distribution, which would not include payment to another DAF, by the end of the following taxable year and (ii) the private foundation maintains records of the distributions being made from the DAF within the applicable time frame. Thus, the proposal would effectively apply to DAF grants the rules that currently apply for purposes of treating grants from a private foundation to a controlled organization or to a private non-operating foundation as qualifying distributions. A private foundation would still be permitted to make grants to DAFs that do not meet the new requirements, but these grants would not count towards satisfying the minimum distribution requirement.
The use of DAFs to satisfy a private foundation’s minimum distribution requirement also was flagged as an area of potential concern by the Internal Revenue Service (the “Service”) in Notice 2017-73 (the “Notice”).[2] In the Notice, the Service and Treasury requested comments regarding whether, consistent with the purposes of Code section 4942, grants by a private foundation to a DAF should be treated as qualifying distributions only if the funds are distributed by the DAF within a certain timeframe. In its responses to the Notice, the American Bar Association Section of Taxation advised that such a time limitation would place an unnecessary restriction on private foundations because, as with any grant by a private foundation to a public charity, when a private foundation makes a grant to a DAF it legally relinquishes control over the grant funds and commits such amounts to the carrying out of the sponsoring organization’s charitable purposes.[3]
An identical proposal was included in the Green Book for fiscal year 2023.[4]
Proposal for Treatment of Payments to DQPs
Under current law, payments of non-excessive compensation by a private foundation to a DQP for reasonable and necessary personal services are generally considered qualifying distributions, because they are payments of reasonable and necessary administrative expenses.
The proposal would exclude from treatment as a qualifying distribution any payments to DQPs, other than foundation managers who are not related to any substantial contributor to the private foundation. A private foundation would still be permitted to pay reasonable compensation to DQPs for services to the private foundation, provided that it complies with applicable self-dealing rules, but these payments would not count towards the minimum distribution requirement.
A similar proposal was included in section 4 of the Accelerating Charitable Efforts Act (the “ACE Act”).[5]
Conclusion
We are available to discuss the Green Book proposals and we will continue to monitor developments in this area.
[1] The 2024 Green Book is available here.
[2] Notice 2017-73, Request for Comments on Application of Excise Taxes With Respect to Donor Advised Funds in Certain Situations, 2017-51 I.R.B. 562, available here.
[3] The Comments on Notice 2017-73 from the ABA Section on Taxation is available here.
[4] The 2023 Green Book is available here.
[5] Accelerating Charitable Efforts Act, H.R. 6595, 117th Cong. § 4 (2022), available here.