A Coalition’s Slate of Philanthropy Reforms Looks to Galvanize Giving, Close Loopholes

One of the recurring knocks against philanthropy is the stinginess of wealthy donors and foundations, relative to their ever-accumulating wealth.

U.S. foundations, often hewing to the legal minimum of 5% annual payout in the pursuit of perpetuity, have amassed over $1 trillion. Donor-advised funds have grown to more than $120 billion, allowing contributors to reap immediate tax benefits with no obligation to distribute anything to an actual charity. Billionaires gave at rates lower than the average American, while those who opened the vaults couldn’t give money away fast enough to keep pace with their swelling portfolios.

All of this is perfectly legal. U.S. tax laws “do not sufficiently incentivize DAFs and private foundations to distribute their funds to charities in a timely fashion, even though donors receive tax benefits upfront,” said Boston College law professor and DAF critic Ray Madoff.

With the health and economic effects of COVID-19 pushing charities to the brink, Madoff, billionaire philanthropist John Arnold and other major players in the sector want to fundamentally change the status quo with the Initiative to Accelerate Charitable Giving, a coalition that seeks to promote “common-sense, non-partisan charitable giving reforms that increase and accelerate resources to working charities, and make the philanthropic sector more effective.”

The coalition, whose members include leaders from the Ford, Hewlett and Kresge foundations, philanthropists like Seth and Beth Klarman and Kat Taylor, and Stanford Political Science Professor Robert Reich, announced a set of policy recommendations to incentivize higher foundation payouts, ensure DAF dollars are distributed within a reasonable period of time, and stimulate individual giving by extending the new non-itemizer charitable deduction in a cost-effective way.

The proposal will face considerable pushback from opponents of further regulation within the sector, who have fought off past reform efforts. Elise Westhoff, head of conservative donor network The Philanthropy Roundtable, swiftly opposed the plan, stating that it would “impose special and unnecessary regulations on private foundations” and “undermine many of the advantages of DAFs—America’s fastest-growing charitable-giving vehicles.” Westhoff’s criticisms include that the changes would add unnecessary mandates for family foundations, infringe on donor privacy, and set an “arbitrary time horizon” on giving that would be better left to donor discretion.

While this debate and the new proposal may sound familiar, the initiative “is the first time that there has been an organized effort by philanthropists, foundation leaders, academics and other leaders in the philanthropic sector to work together to develop meaningful reforms to increase the flow of funds to working charities,” said Madoff, who crafted the plan with John Arnold. “This show of support marks an important and historic change from the past.”

Reforming the 5% foundation payout

The first part of the initiative’s three-point plan involves reforming the 5% payout requirement “to ensure a regular flow of donations from these organizations to working charities, which is especially important now as the nation wrestles with the disproportionate economic and health effects of COVID-19,” Madoff said.

This issue has always been contentious, but generated a considerable amount of debate since the pandemic struck. Some foundations, citing the unprecedented nature of the crisis, exceeded the usual giving levels. Others refrained from taking the plunge, fearful that such a move would threaten their commitment to perpetuity and long-term flexibility.

The initiative asks Congress to reduce to zero the private foundation excise tax for any year in which a foundation’s payout exceeds 7% or more, and eliminate the tax for any newly created, time-limited foundation with a life span of 25 years or less.

In other words, the plan does not ask Congress to force foundations to go above and beyond 5%. Instead, “it simply provides an incentive for those that do,” Madoff told me. “We understand that some foundations have been established to exist in perpetuity and we understand that commitments to perpetuity may affect a foundation’s choice about current versus future spending.”

The proposal also attempts to shore up the rule requiring at least 5% of a foundation’s assets are paid out. “The purpose of this rule can be easily avoided,” the initiative states, thanks to loopholes in the tax code.

The plan asks Congress to stipulate that foundations cannot meet their payout obligations by paying salaries or travel expenses of foundation family members or by making distributions to DAFs. It also asks Congress to mandate that “donors cannot avoid private foundation status (with its attendant rules) by funding their entities through DAFs.”

Getting more DAF dollars into the hands of charities

The plan’s second area for reform centers on DAFs. Currently, funds can sit in DAFs for perpetuity. The plan incentivizes payout by allowing donors to choose one of two regimes.

The first calls on Congress to create 15-year DAFs. Under this proposal, the donor would get upfront tax benefits—but only if the funds are distributed no later than 15 years from the year of the donation. Alternatively, donors could elect an “aligned benefit rule,” whereby they would continue to receive capital gains and estate tax benefits upon donation, but “would not receive the income tax deduction until the donated funds are distributed to the charitable recipient,” according to the initiative. Funds would also have to be distributed no later than 10 years after the death of the donor.

DAF sponsors like Fidelity, Vanguard and Schwab, as well as community foundations, will likely frame the proposals as onerous and costly. Yet Madoff maintains that the payout rules “would not impose any undue burdens and would be easy to implement because the 15-year rule would simply require donors to name a charity that would receive any remaining funds at the end of the 15 years.” The aligned benefit rule, meanwhile, “would only require sponsors to notify donors of their annual distributions, something they are no doubt already doing.”

As IP’s Michael Kavate noted after DAF sponsors dodged reform efforts in California, proponents also argue that calls for change are overblown since DAFs have had much higher giving rates than foundations despite any requirement. Madoff isn’t so sure. “DAF payout rates vary tremendously,” she told me.

Citing an October National Bureau of Economic Research working paper she co-authored with James Andreoni, she said, “While some sponsors pay out at relatively high rates, looking at the most recent data, 24% of DAF sponsors had payout rates of less than 5%.”

Madoff’s research has also uncovered a high degree of variability among DAF account holders. “We know that lots of people use their DAFs to fund their annual giving with appreciated property,” she said. “If 20% of donors use their accounts that way, the DAF sponsor can have a 20% payout rate even if the other 80% don’t pay out anything.”

Spurring individual giving

Lastly, the plan aims to address the 90% of Americans who receive no tax benefit for their charitable giving, which skews philanthropic impact toward the wealthy. The coalition is asking Congress to expand and extend the CARES Act’s new non-itemizer charitable deduction. Such an approach, the initiative’s members argue, should increase the amount of giving and number of donors, minimize the potential for fraud, be administrable by the IRS, and continue to exclude donations to DAFs and private foundations while maintaining a prohibition of non-cash gifts.

“If you’re wondering about the disparity between the immense philanthropic wealth in this country and the daily fight most charities have to wage to stay alive, look no further than charitable tax laws,” said Arnold. “The rules disincentivize philanthropists from giving with any sense of urgency: Foundations and donor-advised funds get immediate tax breaks, and feel no pressure to deliver resources to where they are needed: charities solving this generation’s most pressing problems.”

Arnold expects more big names to sign on to the initiative soon. “Every week, we’re getting people from across the whole spectrum who are joining the coalition,” he said. “I expect that momentum to continue.”

To be clear, the initiative will face pushback from some powerful and respected forces in the sector. But even the initiative’s most staunch opponents must acknowledge that the laws currently governing the charitable sector were passed by Congress in 1969—the same year we put a man on the moon.

“There is a growing recognition of the need to update our charitable tax rules so that they conform to our values,” Madoff told me. “Whether you’re interested in good tax policy or getting more money to charities and all the beneficiaries they serve, the Initiative to Accelerate Charitable Giving’s reforms address both sides of the equation.”

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