Pledges and donor advised funds don’t mix

Why can’t I fulfill the pledge to my favorite charity from my donor advised fund?

IRS rules prohibit a donor from fulfilling a legally enforceable pledge with a payment from a donor advised fund (DAF). Some background information surrounding a DAF will help explain this issue.

Donor advised fund

The term donor advised fund refers to an account held at a sponsoring organization, often a community foundation. The DAF is owned and controlled by the sponsoring organization and the donor retains only advisory privileges over the distribution or investment of the funds in the account. When a donor makes a contribution to a DAF, the sponsoring organization has legal control over it and the donor is eligible to take a charitable tax deduction for this completed gift. It is important to note that even though the donor has retained “advisory” privileges over the money in their DAF, the owner of the funds is the sponsoring organization and all funds are ultimately controlled by the sponsoring organization. The donor is limited to making recommendations only. While most sponsoring organizations will routinely approve a donor’s request, it is under no legal requirement to comply with a request.

Fulfilling a legally enforceable pledge

Since the donor has advisory privileges over distributions from the DAF, many donors believe they can simply request a distribution from their DAF to fulfill their legally enforceable pledge. But the money held in the DAF belongs to the sponsoring organization, not the donor, and the donor can’t legally obligate the DAF.

A charitable pledge is an obligation of the donor to give money at a future time. If the sponsoring organization (the owner of the funds) relieves the donor of the obligation to fulfill their pledge, the donor is receiving an impermissible “prohibited benefit.”

Excise taxes

Donor tax: A tax of 125 percent of the prohibited benefit resulting from the distribution may be imposed on the donor who received the prohibited benefit.

Fund manager tax: If a tax is imposed on a prohibited benefit received by a donor, a tax of 10 percent of the amount of the prohibited benefit may also be imposed on any fund manager who agreed to the distribution knowing that it would confer a prohibited benefit.

Many community foundations with donor advised funds are sending letters along with the checks they issue to charities, asking the recipients of funds to certify that the monies are not being used to fulfill a legally binding pledge. Sometimes, this is the first time the recipient organization learns that the donor intended to pay their pledge from a DAF. Usually the donor is unaware of the associated excise taxes involved.