Paul L. Caron

Friday, February 7, 2020

Weekly SSRN Tax Article Review And Roundup: Holderness Reviews Brunson's Donor-Advised Funds And The Deferral of Charity

This week, Hayes Holderness (Richmond) reviews Sam Brunson (Loyola-Chicago), 'I’d Gladly Pay You Tuesday for a (Tax Deduction) Today': Donor-Advised Funds and the Deferral of Charity, 55 Wake Forest L. Rev. ___ (2020).

Holderness (2017)Perhaps one of the most entrenched deductions available under the Internal Revenue Code is the deduction for contributions to charitable organizations. Though the deduction has its opponents, it just feels right to the national psyche (perhaps too right, making it hypersalient, as Lilian Faulhaber exposed in a 2012 article). The broad appeal of the deduction may lie in its many potential justifications, such as relieving the government of spending it would otherwise have to do, facilitating civic engagement by letting the donor direct government funds, respecting the notion that spending on others should not be considered personal consumption, and incentivizing the socially beneficial behavior of helping others. In his forthcoming article, Sam Brunson highlights the failure of donor-advised funds to live up to the high goals of the charitable deduction.

Donor-advised funds are funds run by organizations that qualify as public charities. A donor makes a contribution to the sponsoring organization, which then creates a separate account for that donor reflecting the contribution. After seeking the advice of the donor, the organization distributes the funds to another public charity at some time in the future. The key appeal to the donor is the ability to take the charitable deduction today, though their money is put to charitable activities tomorrow. This ability is arguably concerning because it is unclear when, if ever, the money generating the charitable deduction will be put to charitable use and because the donor gets a personal benefit in the ability to control how the funds are distributed—if the funds eventually do not go to causes deemed to be in the public interest, then the donation looks more like personal consumption not deserving of a tax benefit.

In fairness to donor-advised funds, they are not the first type of organization to engage with charitable causes in a way that might raise these concerns. That honor belongs to private foundations, which similarly allow donors to donate funds to an organization, take a deduction today, and direct how the funds will be distributed tomorrow. However, unlike donor-advised funds, private foundations are subject to numerous regulations and restrictions on the tax benefits they generate for donors. These measures reflect the fact that private foundations do not function the same as public charities that engage in charitable activities and receive support from the broader public.

Brunson argues that the problems that donor-advised funds generate can be solved by recognizing that the funds operate more like private foundations than like the public charities the funds are currently treated as. Donor-advised funds allow for the acceleration of charitable deductions and the undue influence of individual taxpayers in determining what causes should be supported. Though the funds do not afford donors the legal control over their money after it is donated that private foundations offer, in practice the separate accounting that donor-advised funds engage in results in the donors retaining de facto control over the funds.

Thus, rather than further complicate the tax law by introducing new statutory provisions to rein in the perceived abuses of donor-advised funds, Brunson submits that each separate account within a donor-advised fund should be examined to see if it qualifies as a public charity. Where there are only a few people contributing to the account, it would not so qualify and would necessarily be treated as a public foundation subject to all the restrictions that come with that treatment.

Brunson makes his case, but at least a few underlying claims might generate pushback. First, Brunson rejects solutions to the problems of donor-advised funds that require treating them differently from both public charities and private foundations, despite their apparent hybrid nature, because of the complexity such solutions would add to the tax code. Brunson does observe that U.S. tax policy generally discourages complexity, but perhaps this area should be an exception to that general policy. Forcing the hybrid instrument into one bucket or the other fails to recognize the full substance of the instrument, presumably to some detriment. Adding another bucket might relieve such harms. Further, donor-advised funds are mostly used by wealthy people and only those taxpayers with enough spending to make them itemizers (a smaller bunch after the 2017 increase to the standard deduction) get the advantage of the charitable deduction. Of course all compliance costs are a drag, but perhaps it is not terribly concerning to ask these particular taxpayers to bear those costs.

Second, to the extent that the issue of allowing a deduction today for a donation tomorrow is a problem to be addressed, it is unclear that the proposed solution best solves it. Admittedly, donors can use private foundations for this benefit, so the real advantage of the donor-advised fund in this regard is that the donor is less restricted in the amount of charitable deduction available. If the IRS begins examining separate accounts in donor-advised funds, it seems reasonable to expect the funds to alter their accounting practices to frustrate the IRS and achieve their donors’ goals. The timing problem instead suggests an alternative path: redefining the concept of charitable use of funds not to include investing funds for future charitable use. In other words, only those organizations actively engaging in charitable activities could qualify as public charities. Brunson does explore whether the timing issue is a problem and critique others’ solutions that more directly address the issue, but the article might benefit from a fuller explanation of the issue’s relation to the proposed solution.

In whole, Brunson does an admirable job of unpacking a complex and timely issue. His arguments and solution are thoughtful and deserving of consideration by anyone concerned with the potential abuse of donor-advised funds by taxpayers seeking to avoid the restrictions accompanying private foundations. I’d gladly engage with Brunson’s work Tuesday, today, and tomorrow.

Here’s the rest of this week's SSRN Tax Roundup:

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