A few weeks ago the following question was posed: Individual ("Charlie") who works for a charity (let's call this charity "ABC") that sponsors donor advised funds suggests to a donor (let's call donor "Notoogullible") that she should establish a donor advised fund account with ABC. Notoogullible was open to the idea but explained that she was currently paying the remaining five years of payments on a pledge to her favorite charity and was not certain that another charitable gift at this time would be appropriate. Anxious to make a new relationship, Charlie suggests to Notoogullible that she ought to fund a new donor advised fund account and then use that account to satisfy the remaining pledge payments. In addition, by funding the account today, Charlie points out to Notoogullible that she will be able to claim a charitable deduction for the entire amount today. Remembering that she could only claim a deduction each time a pledge payment is made, Notoogullible was impressed with the idea. Notoogullible thinks about this for a moment and is concerned that this is too good to be true. Fortunately for Notoogullible, she has good instincts.

A donor advised fund is nothing more than an account maintained on the books and records of a sponsoring charity. Most sponsoring charities will credit each donor's account with a pro rata share of the income and gains that accrue during the course of the year, and will debit each account, on a pro rata basis, for all losses. Some sponsoring charities will also allow each donor to select among a list of mutual fund investments in which his or her account will be invested. Most charities sponsoring a donor advised fund will also charge each account a service fee based on the value of the account. When a donor makes a gift to a charity that sponsors a donor advised fund, the value of the gift usually becomes the opening value of the donor advised fund account. The gift is a completed gift, meaning that once made, the donor will no longer possess the power to control the disposition of the gifted assets, and, subject to any other limitations, will entitle the donor to a charitable deduction. As a result, a donor is limited to making recommendations to the sponsoring charity with regard to the disposition of the donor's account (i.e., who should receive a grant and for how much).

Thus, if Notoogullible establishes a donor advised fund account she will have no guarantee of accomplishing what Charlie suggests. For example, Notoogullible will no longer have the ability to require that grants be made to the charity of her choice. While, in practice, most charities sponsoring donor advised funds routinely approve grants requested by a donor the legal authority to make that decision is solely in control of the sponsoring charity.

However, even assuming the sponsoring charity cooperates, the proposal discussed above presents another problem. Current law expressly prohibits the use of a donor advised fund account to satisfying personal pledges of the donor advisor and certain other related parties. The act would be treated as an excess benefit transaction by ABC charity and could subject ABC, Charlie and Notoogullible to substantial excise taxes and penalties. It is for this reason that most charities sponsoring donor advised funds will issue grant checks from the donor advised fund with a cover letter which states that the acceptance of the check by the grant recipient is an affirmation by the recipient that the payment does not satisfy any personal obligation of a donor advisor.

This is an important example of why making a charitable gift can be a tricky business. The laws impacting charitable organizations (including a family foundation) and the use of foundation funds are complicated. If you are involved with a charity or are thinking of becoming involved with one, make sure you seek experienced, skilled professionals to work with you and your organization. The consequences of missteps in starting or administering the organization can extend far beyond the income tax ramifications.

Suppose ABC suggests an alternative approach: that Notoogullible cancel the prior pledge to her favorite charity. After the pledge has been canceled, Notoogullible would establish the donor advised fund account with ABC and request that the donor advised fund enter into a new pledge which would cover the remaining obligations of Notoogullible as they were written before the original pledge had been cancelled. The August edition of the Schiff Hardin LLP Tax-Exempt Organizations newsletter will discuss the viability of this alternative.

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