An Interview with Donor Advised Fund Expert Peter Smith

By | 2018-02-13T15:39:40+00:00 February 13th, 2018|

Corporate Social Responsibility programs have a tremendous impact on the communities in which we live and work. One such impact is through giving programs that raise several billion dollars annually for charitable organizations. Many of these giving programs depend upon a Donor Advised Fund (DAF) to receive, receipt and distribute charitable gifts around the world. But DAFs are often the overlooked – or even misunderstood – key player in the raising and distribution of hundreds of millions of CSR program dollars.

Peter Smith, The Apex Law GroupCSR Matters caught up with Donor Advised Fund expert, Peter Smith. Based in Seattle, WA, Peter’s practice specializes in social benefit organizations. And that means that DAFs sit squarely in his “subject matter expert” sights. We sat down with Peter to discuss the topic of DAFs and Corporate Social Responsibility. You may find Peter’s contact information at the end of this interview, below.

Q1: Peter, thanks for joining us, and welcome to CSR Matters. Please give us a quick definition of a DAF.

Peter: A Donor Advised Fund is a charitable giving account administered by a public charity that manages charitable donations on behalf of organizations, families, or individuals. To participate in a donor advised fund, a person or organization opens an account and deposits cash, or sometimes securities. The donor surrenders ownership of anything he or she puts into the fund, but retains advisory privileges over the investment of the account and distributions to charities.

Q2: You have a unique skillset in terms of your focus on social business structures such as Benefit Corporations and donor-advised funds. How did you decide to develop your practice in this direction?

Peter: I started my current practice 7 years ago knowing a lot about for-profit corporate law and a lot about nonprofit corporate law. I would meet often with clients that fit into those two boxes.   But what I quickly realized was that I spoke with a lot of entrepreneurs who needed someone who understood those two corporate worlds, and how to fund those corporate entities, at the same time.  Someone who could help them take a social business and choose a pathway (for-profit or nonprofit).  Then the benefit corporation sprung up, and the Social Purpose Corporation here in WA sprung up and I decided: “No one will know more about these entities than me.”  They may know as much as I do, I’ll give them that, but starting on day 1 I pushed myself to own the space.  And now here I am, seven years later and very happy that I know a lot about the space.

Q3: What aspects of donor-advised fund law do you find most interesting or challenging?

Peter: Donor Advised Funds (“DAFs” for short) are interesting because they are such an incredible tool for tax-deductible giving.  Without having a donor administer their own nonprofit entity, they can get the deduction they deserve and direct their giving in a way that matters to them most.  And they are a challenge because DAFs occupy this grey space in IRS regulations for tax-exempt entities. They are 501c3 public charities, but there are special rules and regulations for DAFs that make them seem like private foundations (which have more restrictive regulations than private charities).

Q4: I encounter a lot of people who think of a DAF as a type of charity. What is the difference between the DAF and the charity sponsoring the DAF?

Peter: The DAF is a fund within a 501c3 public charity.  Think of it as a separate account or fund that the charity owns. The accounting is such that the charity keeps track of which donors have advisory privileges over what money.

Q5: Does a 501(c)3 require IRS approval to create and sponsor a DAF?

Peter: Yes.  In fact, a new org trying to operate a DAF and obtain c3 approval from the IRS cannot use the 1023-ez application for tax-exempt status; it must use the full blown 1023 form.  And the IRS requires existing c3’s that sponsor DAFs to state on their 990 that they are operating such a fund.

Q6: Is there a common misperception about the governance of a DAF that you encounter and wish you could correct once and for all?

Peter: I think what I want to impart on people is that operating a DAF isn’t rocket science. It’s a bit difficult with respect to the regs and it is relatively new, but DAFs aren’t something to be afraid of because of some kind of overbearing governance regs.

Q7: Same question but about donors: is there a common misperception about DAFs that you have encountered from donors?

Peter: Yes, donors seem to fear that they don’t have control over gifts and thus shouldn’t use DAFs.  I think that’s hogwash because the point of the DAF is that the donor can make the advisement. The DAF is responsible for oversight of the advisement – it cannot allow grants to go to individuals, non-tax-exempt orgs, etc. – but any DAF that doesn’t honor the legitimate advisements won’t be around for long.  They can’t afford to ignore donor wishes.

Q8 lead-in:

CSRM: Pardon the long preamble to this question, but I think the set-up is helpful. At Good Done Great, where I was the CFO, we partnered with DonateWell to disburse donations made through our giving software, used mostly by companies supporting corporate social responsibility (CSR) programs. The structure of the Donor Advised Fund aligned with our mission as an innovative company seeking to improve the giving experience for donors, and the DAF enabled us to significantly reduce disbursement costs associated with managing those CSR programs.  Some companies, however, would not use the DAF because they worried about the DAF “taking possession of the donation” prior to processing the disbursement. We usually discovered at the heart of this objection was corporate counsel who did not sufficiently understand laws governing a DAF.

Q8: Please shed light on what happens legally when a donor contributes money to a DAF and then requests a grant?

Peter: When a donor makes a gift to a c3 operating a DAF, the gift is COMPLETED.  That means, legally, the donor has no further legal authority over the money, the c3 does.  But the c3 will take the “advice” from the donor of where the money should go. And so long as the donor points the donation to a qualified charitable entity or purpose, the c3 DAF will usually make the gift (and that second gift is from the c3 DAF to the receiving charity or grantee).  Now the business reality of this is simple – c3’s will just about ALWAYS make the gift!  It takes something drastic (e.g. insider giving or the c3 grantee has lost its tax-exempt status) before a Donor Advised Fund rejects a gift advisement.  You can’t operate a DAF with a reputation for ignoring the original donor’s wishes because you won’t be operating for long.

Q9: There are many benefits when corporate workplace giving programs utilize a DAF to receive and disburse contributions. For example, cost savings, greater transparency tracking the gifts, assurance of gift receipting at the point of donation. That said, are there any negatives or risks that should be pointed out?

Peter: DAF’s are a great tool. But because they are not regulated as heavily as private foundations, the IRS scrutinizes these charities CLOSELY with their audit resources.  They are an immediate yellow flag for the IRS.  Not only that, but because they DAF occupies this grey space between private and public charities, sometimes it is unclear in the Code which rules apply to a DAF, and this is especially true with international giving.  So the down side is grey area in regulation plus increased scrutiny: the downside is legal risk.

Second downside. Unfamiliarity in the marketplace.  I still see my clients forced to do a lot of educating about the DAF.

Q10: A number the more well-known DAFs such as Fidelity Charitable Trust and Charles Schwab Charitable Trust market the benefit of allowing donors to invest their funds, while making grant distribution decisions at a later point in time. Would you please talk a bit about the benefit of this characteristic of a DAF?

Peter: Great point. So, not only is the donor allowed to advise on the gift disbursement to a charity, but the donor can also advise on how to grow the principal donated to the DAF.  Should it be invested, in what funds, for what level of desired return, etc.  The reality is that, with Fidelity and Schwab is that you have an opportunity to make a gift, then grow that gift, and then make the donation later for more money.  It’s a strong way to leverage impact.

Q11: What is the difference between a DAF and a private foundation?

Peter: A DAF and a private foundation have similar rules, but there is a large upside to a DAF.  Private foundations and DAFs have prohibitions against insider dealings (money that comes out that benefits the original donor) and excess business holdings (prohibition on owning any more than 20%, typically).  Where the DAF is different is that there isn’t a prohibition against jeopardizing investments (a Private Foundation has to really justify how it invests its endowment, no startups except under VERY close scrutiny and situations justifying an investment) and there isn’t a requirement to make distributions to charities.  Generally, a private foundation must make qualifying distributions equal to 5% of the average market value of its net investment assets in order to avoid paying excise taxes.  Finally, Private Foundations must pay a 2% tax on their net investment income (1% in some cases).  This is not the case for DAFs.

Q12: Are there any restrictions to a private foundation granting money to a DAF? For example, could a donor have both a private foundation and a DAF, and grant money between them?

Peter: This is a great question, I’ve never been asked this before!   As a note, I represent public charities, and not private foundations so I don’t dig this deep normally.  The answer here is maybe from a technical standpoint, but absolutely not in reality.   The regulations suggest that a Private Foundation can give to a DAF – no qualifying grants when an insider, directly or indirectly, controls the entity where the gift is made unless the grant is then passed on to a qualified organization within 1 year from the end of the tax year when the gift was made AND the foundation has to track and prove with adequate documentation that this second disbursement happens.  That’s a lot of qualifications just to make a gift and then have the DAF make another gift. So, the business reality here is that there is nothing for the private foundation to gain by doing this. So, why not make the grant direct and avoid the hassle?

Q13: What is the difference between a 501c3 org that receives donations designated for other charities and processes those donations to the designated charities (e.g. United Way, America’s Charities) and a 501c3 that sponsors a Donor Advised Fund account for donors?

Peter: The former – the United Way, for example – receives donations from a donor and receipts the gift. Then “by promise” processes the donation to the recipient charity, usually a member of the United Way. There is no “fund” or account held in the name of the donor, no potential for the appreciation of the value of the fund. It winds up being an “ear-marked gift.” The DAF is a means of holding funds, allowing them to appreciate, and a means of disbursement. Both the United Way and the DAF take legal possession of the funds given.

Q14: As counsel for one or more DAFs, you have helped navigate the complex waters of banking regulations, including the determination of who is and is not a ‘money transmitter’. Three-part question:
  1. What is a money transmitter?

Peter: Well there is a legal definition from FinCEN – the Financial Crimes Enforcement Network, an office of the US Department of the Treasury. But the reality is that “money transmitter” refers to a third-party who receives money from one party and sends it to the next party by instruction.

  1. Why is a DAF not a money transmitter?

Peter: Because the gift is completed when it hits the DAF Account.   The $ can stay for 100 days, 1000 days, indefinitely, or be transferred to a nonprofit immediately.

  1. What recommendations do you have for any DAF struggling to understand these regulatory complexities?

Peter: They should reach out to counsel.  But to me a DAF does not fit the spirit of the regs.  If a DAF is a money transmitter, then isn’t a private foundation?  Should the Gates’ foundation be regulated in this way? What about gifts earmarked for a certain cause or charity, like in most cases with the United Way?  Even in those cases it doesn’t seem to fit what FinCEN is trying to accomplish within the US Treasury Department.  Now, this is not my public free legal opinion on the matter, its just my policy position. Each case can be different.  Again, reach out to counsel because this is a complicated area.

Q15: If someone has questions about a Donor Advised Fund – whether a donor, a company sponsoring CSR giving programs, or a nonprofit – how can they best reach out to you for assistance?

Peter: Website is best, email is second best, and twitter is third best!

About the parties in this interview:

Peter Smith is a partner with The Apex Law Group, LLP, (www.apexlg.com). Peter focuses on advising social entrepreneurs with the challenges of business formation, including the unique social business structure options available such as nonprofit, donor-advised fund, L3C, Benefit Corporation, and for-profit structures. He has served as legal counsel for a number of nonprofits sponsoring donor advised funds, including DonateWell. Peter can be reached via email at peter@apexlg.com. And via twitter at https://twitter.com/TheApexLawGroup.

CSR Matters (www.CSRMatters.net/About-us) is a consulting practice that specializes in Corporate Social Responsibility, or CSR. We turn corporate consciences into ‘programs with purpose’ that improve the quality of our communities and the value of company brands. Here’s a quick reference about DAFs. Contact us for CSR program assistance.

DonateWell (www.DonateWell.org) is a 501(c)3 charity sponsoring a Donor Advised Fund (DAF). DonateWell’s mission is to democratize DAFs. To expand their availability to donors while speeding the giving process and improving transparency and accountability. DonateWell achieves their mission by partnering with CSR SaaS companies, such as YourCause, and start up companies building the newest fundraising apps, such Cheerity and Public Good Software. In three short years, DonateWell has grown to more than $40 million in grant disbursements.

Good Done Great (GDG) was a CSR software and services company founded in 2009. GDG helped fund and grow DonateWell into a leading DAF in the CSR giving and disbursement industry. In 2015, GDG acquired AmeriGives and WPG Solutions, also CSR service companies. With more than 65 clients, mostly fortune-level, and disbursing in excess of $40 million annually to charities, GDG was acquired by YourCause (www.YourCause.com) in 2017.

About the Author:

A Principal at CSR Matters, Gary has 25+ years of experience working in Corporate Social Responsibility, including nonprofits, software development and the financial services industries. "It's a labor of love. I have a number of professional interests, and they all intersect with CSR." Over the past several years, he has been actively involved in the acquisition, growth and consolidation of a number of companies in the CSR space, including AmeriGives, Good Done Great, WPG Solutions, and Dexterity Ventures, plus donor advised funds DonateWell and Place2Give. Gary's prior experience includes leadership positions with Bank of America, United Way and KindMark. To learn more about the breadth and depth of Gary's operational, financial and executive experience, please visit https://www.linkedin.com/in/gpfcarr/.