What is the ACE Act?
A bipartisan organization, The Initiative to Accelerate Charitable Giving (IACG) supports the academic research of Ray D. Madoff and Roger Colinvaux, law professors at Boston College and Columbus School of Law (The Catholic University of America), respectively. Madoff and Colinvaux work to find new ways to increase the flow of funds from philanthropic vehicles to the nonprofit sector.
Their work has resulted in proposed legislation, called the ACE Act, in the U.S. Senate by Senators Angus King (I-Maine) and Chuck Grassley (R-Iowa). The ACE Act closely follows Madoff’s and Colinvaux’s research and the IACG’s proposals.
The goal of the ACE Act is to achieve greater fund flows to the nonprofit sector by restructuring the rules governing private foundations (PFs) and donor advised funds (DAFs). The act seeks to resolve two perceived issues associated with charitable giving through DAFs and PFs:
- First, it seeks to resolve the timing mismatch between when the donor receives a tax deduction for funding a DAF or PF versus when the operating charitable organization receives the grant.
- Second, it seeks to resolve the perceived issue of donor control in perpetuity. It would seem that donors exerting control over charitable funds from beyond the grave troubles policymakers. Further, as a corollary to perpetual donor control, is the warehousing of funds for generations in private charitable vehicles.
Ultimately, the ACE Act aims to allow for philanthropic funds to be available to the charitable organizations when needed. However, questions exist as to how effective this legislation will be, both in the short and long term.
To illuminate what we believe are the key issues within the legislation that will aid decision-making for donors and public charities alike, we hope you will find the following question and answer format helpful.
How does the legislation impact donors using PFs? How will it change their giving practices?
PFs Using DAFs for Grantmaking
Donors who have PFs often use DAFs to lower their administrative costs, teach the next generation to give wisely or to give anonymously. Also, under current law, distributing funds to a DAF from a PF also counts towards the PF’s annual distribution requirement (generally, 5% of the value of the PF’s assets, subject to certain reductions and exclusions). The ACE Act would no longer allow distributions to DAFs from PFs to count towards the PF’s required annual distribution unless the DAF acts as a true conduit to the ultimate grant recipient. Grant monies received by a DAF from a PF would have to be distributed from the DAF by the close of the first taxable year after the grant was received. For example, if a PF made a grant to a DAF on November 15, 2021, the DAF would have to make a grant to a public charity in the same amount by December 31, 2022. Failure by the DAF to make the grant within the required time frame would cause the PF’s grant to the DAF to not be qualifying distribution counted toward the PF’s annual distribution requirement. Failure by a PF to fully fund its annual distribution requirement could result in the PF being subjected to excise taxes of 30% of the undistributed amount, and if not corrected, 100% of the undistributed amount.
Administrative Expenses vs Excise Taxes
Under current law reasonable and necessary administrative expenses of a PF count toward its annual distribution requirement. Under the ACE Act, salary, travel and other administrative expenses paid to family members of (i) a substantial contributor to the foundation or (ii) an owner of more than 20% of the total combined voting power of a corporation, the profits interest of a partnership, or the beneficial interest of a trust or unincorporated enterprise, which is a substantial contributor to the foundation would not count toward the annual distribution requirement. Administrative expenses paid to a foundation manager who is not a family member described above would continue to count toward the annual distribution requirement. Failure by a PF to fully fund its annual distribution requirement could result in the PF being subjected to excise taxes of 30% of the undistributed amount, and if not corrected, 100% of the undistributed amount. Accordingly, under the ACE Act, to fulfil its annual distribution requirement a PF would likely need to increase its grant-making to replace disqualified administrative expenses.
Incentives to Make Larger Grants or Create Spend Down Foundations
Under current law, a grant-making PF (as opposed to an operating PF) must pay a 1.39% excise tax on its net investment income. The ACE Act would encourage PFs to make larger qualifying distributions (generally grants to charitable organizations) by waiving the tax on net investment income for PFs that distribute at least 7% of the value of the PF’s assets (excluding assets used for the PF’s exempt purposes).
The ACE Act would also encourage “spend down” PFs by eliminating the tax on net investment income for a PF with a maximum duration of 25 years, as specified in its governing instrument, and that makes no distributions to “disqualified private foundations”. For these purposes, a “disqualified private foundation” is any private foundation that has a disqualified person who is also a disqualified person with the foundation making the distribution.
How does the ACE Act impact DAF donors? How will it change their giving practices?
DAF Types Attempt to Solve the Timing Mismatch Problem
The ACE Act divides DAFs into four new categories. The tax consequences to a donor who makes gifts to a DAF would differ depending upon the type of DAF that receives the gift. These provisions attempt to reduce the timing mismatch between when the donor receives a federal income tax deduction and when a DAF makes a grant to a charitable organization.
Qualified Donor Advised Fund (QDAF): Pursuant to the ACE Act, a QDAF is a DAF established under an agreement that requires, for the duration of the fund, the termination of any advisory privilege with respect to any contribution (including any earnings thereon) made by any donor (or any person appointed or designated by a donor) before the fifteenth year beginning after the taxable year in which the contribution was made. The donor must designate “a preferred organization” to receive contributions and the earnings thereon that remain in the QDAF after the advisory period terminates. If the QDAF fails to distribute the contribution (and the earnings related thereto) in a qualifying distribution before the last day of the sixth month following the last day of the fourteenth taxable year beginning after the taxable year in which the contribution was made, the sponsoring organization will face a penalty (an excise tax) equal to 50% of the amount of the contribution and the earnings attributable thereto that had not been distributed by the required date.
A donor who gives a “non-publicly traded asset” to a QDAF would not necessarily receive an income tax deduction for such gift in the year that the contribution was made to the QDAF.
Instead, the deduction would be allowed when the sponsoring organization sells the non-publicly traded asset. The amount of the deduction shall not exceed the gross proceeds received from the sale and credited to the taxpayer’s account.
For these purposes, a non-publicly traded asset is “any asset for which (as of the date of the contribution) market quotations are not available on an established securities market.” A donor who contributes assets other than non-publicly traded assets to a QDAF should receive a charitable deduction in the year of the contribution (subject to the regular rules governing charitable deductions).
Non-Qualified Donor Advised Fund (NQDAF): Pursuant to the ACE Act, an NQDAF is a DAF that must distribute a contribution (and the earnings related thereto) in a qualifying distribution before the last day of the sixth month following the last day of the 49th taxable year beginning after the taxable year in which the contribution was made. If the QDAF fails to distribute a contribution (and the earnings related thereto) in a qualifying distribution before that date, the sponsoring organization will face a penalty (an excise tax) equal to 50% of the amount of the contribution and the earnings attributable thereto that had not been distributed by the required date.
A donor who gives property other than cash to a NQDAF would not necessarily receive an income tax deduction for such gift in the year that the contribution was made. Instead, the deduction would be allowed when the sponsoring organization sells the contribution for cash and then only in the year that includes the date that the sponsoring organization made a qualifying distribution of the sale proceeds.
The amount of the deduction is limited to the amount of the qualifying distribution. A donor who gives cash to a NQDAF, would not necessarily receive an income tax deduction for such gift in the year that the contribution was made. Instead, the deduction would be allowed in the year that includes the date that the sponsoring organization made a qualifying distribution of the contribution. The amount of the deduction is limited to the amount of the qualifying distribution.
Qualified Community Foundation Donor Advised Fund (QCF-DAF): There are two types of QCF-DAFs, both of which must be sponsored by a Qualified Community Foundation (QCF). A QCF is an organization described in IRC § 501(c)(3), which is organized and operated for the purpose of understanding and serving the needs of a particular geographic community that is no larger than four states by engaging donors and pooling donations to create charitable funds in direct furtherance of those needs and which holds at least 25% its total assets outside of DAFs. There are no specific provisions regarding issue-based community foundations, such as National Christian Foundation or DAFs sponsored by universities, hospitals or larger nonprofits1. A QCF-DAF is a DAF maintained by a QCF and either each individual who has advisory privileges may only have such privileges with respect to one or more DAFs held by the QCF with an aggregate value at any time of $1 million or less, adjusted for inflation after 2021 (for our purposes, a size-limited QCF-DAF), or the DAF is established under an agreement that requires that the fund make “qualifying distributions” each calendar year in an amount not less than 5% of the value of the fund determined as of the last day of the preceding calendar year (for our purposes, a minimum distribution QCF-DAF).
A donor who makes a gift to a QCF-DAF would have the same tax consequences as a donor who makes a gift to a QDAF, described above.
Anonymity: Changing How DAFs Make Grants to Public Charities
The ACE Act may change the way DAFs make grants to public charities. Certain organizations, informally called “public charities,” are excepted from private foundation status. However, to maintain public charity status, the organization must meet certain financial tests, such as the “one-third support test.” The ACE Act limits how grants from DAFs can be used by 501(c)(3) organizations to qualify as public charities.
One often desirable feature of a DAF is the ability of the DAF’s donor to request the DAF make anonymous grants to charitable organizations. As such, if the sponsoring organization accepts the donor’s advice, the grant to the charitable organization need not bear the donor’s name.
The ACE Act limits how grants from DAFs are counted when determining whether a charitable organization is a public charity. Pursuant to the ACE Act, unless an exception applies, distributions from sponsoring organizations to a recipient charitable organization will be treated as support received from one person (not a public charity), thereby limiting how much of the grant may be used to determine if the recipient organization qualifies as a public charity. If, however, the sponsoring organization identifies the donor to the DAF making the distribution, the grant will be treated as having been made by the DAF’s donor (rather than the sponsoring organization).
If the sponsoring organization makes a grant to a recipient organization from funds that are not from a DAF and over which no donor had advisory privileges, the grant shall be treated as coming from an organization described in IRC § 170(b)(1)(A) and not limited for purposes of testing the recipient organization’s status as a public charity. If the ACE Act passes in its current form, it will be interesting to see if public charities decline to take anonymous grants from DAFs.
What impact could the ACE Act have on charitable organizations?
Notwithstanding the ACE Act’s good intention of speeding funds from donors to charitable organizations, the public policy implemented by the act may be detrimental to those charities.
Public Support Test
A 501(c)(3) organization must meet certain financial tests to be considered a public charity. Generally, the public support test requires a public charity to demonstrate that one-third of the grants that it receives comes from donors who give less than 2% of its overall support.
Under the ACE Act, grants received by an organization from organizations that are DAF-sponsoring organizations will no longer be treated as coming from a public charity. Instead, unless an exception applies, distributions from a sponsoring organization to a recipient charitable organization will be treated as support received from one person, thereby limiting how much of the grant may be used to determine if the recipient organization qualifies as a public charity. However, if the recipient organization wishes to count each grant from a DAF as an individual grant, the sponsoring organization must identify the donor to the DAF making the distribution.
If the sponsoring organization makes a grant to a recipient organization from funds that are not from a DAF and over which no donor had advisory privileges, the grant shall be treated as coming from an organization described in IRC § 170(b)(1)(A) and not limited for purposes of testing recipient organization’s status as a public charity.
This discourages anonymous giving from DAFs to public charities as it would limit the ability to count anonymous gifts from multiple DAFs as multiple gifts. This could hurt new, grassroots, and small charitable organizations that cannot afford to hire development staff to monitor donations, potentially causing a small charity to fail the one-third public support test and be classified as a private foundation. Additionally, public charities with sensitive or controversial missions often rely on anonymous donors to meet their needs. Such entities could see their funds flow reduced because of this potential change in policy.
Passing a PF or DAF from generation to generation to transfer values, a sense of community and generosity has long been a goal for many families. Leaving such a legacy can be a challenge, as each generation has a distinct worldview, with different goals, dreams and ideas and the methods to accomplish them. The ACE Act seeks to set a time limit on family legacies, based on the belief that perpetual giving may hinder the flow of funds to charitable organizations and communities in need now. Yet, consider the other side of the argument: many charitable organizations are perpetual and will need donors for generations to come. Why not allow families to save funds in a tax-advantaged way for future philanthropic support?
Interestingly, human need and nature may be ahead of the public policy found in the ACE Act. The COVID-19 pandemic has been a watershed moment for many and has increased awareness of unrestricted giving.
Finding new ways to attract the next generation of philanthropists and incentivizing donors to give unrestricted funds could be an alternative way to solve the perceived problem of perpetuity.
The efforts of the ACE Act to resolve the timing mismatch in the current system of charitable giving may indeed hurt the very charitable organizations policymakers seek to help. By forcing maximum time horizons on DAFs and PFs, donors simply may wait until the expiration of the permitted holding period, thereby forcing charitable organizations to wait for grants for the maximum amount of time allowed (15, 25 or even 50 years).
Further, it is not unreasonable to expect a rush to create and fund PFs and DAFs prior to enactment of the ACE Act, thereby “locking in” the rules that exist today. This rush to lock in the old rules could draw increased funds into DAFs and PFs that would otherwise be distributed to operating charitable organizations now. Accordingly, the burden on nonprofit development staff members would not be resolved by this legislation.
Finally, concerns over the timing mismatch between when a tax deduction is taken and when the grant is made assume that being a philanthropist is a business, driven only by tax advantages that can be obtained by giving. While taxation may be a motivating factor in philanthropy, it is certainly not the only one. The desire to help solve problems encourages working in partnership with charitable organizations in communities. To help solve problems in our communities requires more than just money. It requires collaboration between individual donors, nonprofit organizations, for-profit organizations and government.
Although the debate is ongoing, with respect to the ACE Act, the bottom-line questions are:
- Can this legislation achieve its goals?
- Will it be passed as written?
- And if not, what parts of this legislation will most likely pass now and what parts may pass as part of other legislation down the road?
In the meantime, the value of our uniquely American nonprofit sector to our communities is clear.
Philanthropy is not going away. Although we cannot see the future, it is entirely possible that PFs and DAFs will face increased regulation. Yet, fundamentally, public policy can increase the joy of giving, rather than diminish it. Whatever legislation is passed to address issues (whether real or not) involved in charitable giving, the human desire to help, give and love will likely continue to drive capital to solve human problems. In that way, we are meeting the moment each day.
For more information, please contact your PNC Private Bank Hawthorn advisor.
1Morgan Lewis, Publication, Accelerating Charitable Efforts Act Introduced, June 11, 2021, https://www.morganlewis.com/pubs/2021/06/ accelerating-charitable-efforts-act-introduced (last accessed October 20, 2021).