Nonprofit Funding 101: What are Donor Advised Funds?

Nonprofit organizations rely on donations to keep them afloat and do the work that comprises their mission. Donations may come in small amounts and be used immediately – but that’s not the only way people can donate.

One option you may not be familiar with is a Donor Advised Fund, or DAF. Recently, we’ve had some of our nonprofit clients at Addition Financial ask us about these funds and how they work. Here’s what you need to know.

What is a Donor Advised Fund?

Let’s start with a definition. A Donor Advised Fund is a form of nonprofit funding that starts with a donation – typically a large one – from a donor. The money is placed into a fund and the donor is then free to take the maximum tax deduction allowed by the Internal Revenue Service.

DAF’s may be administered by a nonprofit organization or, in some cases, by an investment firm. The money is held in trust and may be invested. Any gains on the investment are tax free. The donor may appoint advisers, successors and (for a fund held by an investment firm) charitable beneficiaries.

While DAF’s are getting a lot of attention now – and indeed, are the fastest-growing form of philanthropy in the United States as of 2018 – they are not new. The very first Donor Advised Funds were created back in the 1930s, although they were not regulated until the passage of the Tax Reform Act of 1969.

Donor Advised Funds increased in popularity in the 1990s and today they account for more than 3% of all charitable giving in the United States.

Frequently Asked Questions about Donor Advised Funds

Donor Advised Funds can be confusing to administer in some cases because there are some gray areas in the rules that govern them. It’s important to adhere to the IRS guidelines to avoid penalties. Here are some of the most common questions we get about Donor Advised Funds, together with our answers.

Who controls the money?

The most frequent question we hear has to do with control of the money in the fund. The short answer is that the sponsoring organization – usually a nonprofit – has responsibility for the money. They may (and often do) seek advice and take recommendations from the donor. For example, a donor may request that the funds be used for a specific project or goal of the organization. The organization is not legally obligated to take the donor’s advice, but most nonprofits do.

Can the money be taken away?

Because money in a DAF is not spent immediately, you might wonder if the donor can change their mind and take the money away. They may not, and the reason is that they will have already taken the full tax deduction allowable when they made the donation.

Can the donor pass the fund on to a successor?

The decision about whether the advisory control of a DAF may be passed on to an heir or successor is up to you. Remember, your organization will have control of the money in perpetuity. It is very common for sponsoring organizations to encourage a donor to name a successor. Again, the funds will not pass to the successor, but they will have the right to advise the sponsoring organization on how to use the funds.

What happens if the donor dies without naming a successor?

When you set up a DAF, you should specify what will happen if the donor dies without naming a successor. Typically, that means after a designated number of years, the money from the fund will pass into your general fund. From there, it may be used in the same way as any other donation you receive.

Is there anything a Donor Advised Fund can’t be used for?

While the donor can give you advice and counsel about how to use the money in a DAF, there are some limitations on what can be done with the money. Some of these apply to funds administered by an investment firm, but we’ll mention them all because you may receive donations that come from such funds.

1. DAF money may not be used to fulfill a pledge. For example, if a donor makes a pledge to a charitable foundation, it’s possible the donor might try to take a separate tax deduction for the pledge. If such a fund makes a donation to you and mentions that it’s meant to fulfill a pledge, you should not accept it.
2. DAF money may not be used to purchase a table at a charity event. The reason is that the donor receives something in return for that money – seats at the table, a meal and whatever else is given to guests.

It’s your job to make sure DAF donations are handled appropriately. That means if you receive a DAF donation from an investment group, you may acknowledge the gift. However, you should not mention it to the IRS because the donor will already have taken a deduction for the original donation.

Donor Advised Funds can be a good way to encourage and manage large donations. To learn more about Addition Financial’s services for nonprofit organizations, please click here now.