Publication: The Charitable Advisor

theCharitable Advisor: January 2019

January 22, 2019

An Interview with Donna Vincenti

The Community Foundation recently sat down with Northwest Connecticut estate planning attorney Donna D. Vincenti to discuss her work advising charitably inclined clients on gift options, tax advantages, and common concerns related to charitable gift planning.

NCCF: When does the topic of charitable giving arise when working with clients?

DV: My estate planning questionnaire that clients complete before we begin the planning process asks if the client has any charitable goals or objectives. About 10-15 percent of clients do. It’s most often a childless couple or a single or widowed client who doesn’t have dependents. Sometimes it’s folks who have a lot of wealth to spare and have been thinking in terms of charitable giving. Often, those who have not given much thought to charitable giving decide to leave a charitable gift as a contingency in the event that all of their loved ones predecease them.

NCCF: Tell us about some of the options for clients who want to give back to their community.

DV: There are a lot of options. If a client wants to make a substantial charitable gift, but wants to retain income for a spouse or child, they might consider a Charitable Remainder Trust (CRT), which would guarantee a fixed income with the charitable goal met at the end of the spouse’s or child’s life. Some clients want to make an outright charitable gift to a charity, but have concerns about how that charity will manage the money and/or what that charity’s mission might be in the future. In that case, I might recommend a designated, field-of-interest or donor-advised fund* with NCCF.

NCCF: Tell us about the tax considerations that affect charitable giving.

DV: Tax considerations come into play when we discuss how to achieve charitable goals. If a client’s required IRA distribution is more than he or she needs or wants added to taxable income, I might suggest a charitable rollover into a field-of-interest fund. With CRTs, clients get a deduction based on an actuarial calculation of the amount passing to charity after the recipient has passed away. A Charitable Lead Trust, where a charity receives a percentage of the fund for a number of years and the client’s children or grandchildren receive the remaining balance, offers a substantial deduction when interest rates are low. There are many tax advantages to giving, but people are not typically motivated by the tax savings. When clients have a charitable goal, I might look at their estates and say, ”here’s one way to accomplish what you want to accomplish and also get a tax deduction.” It‘s just an extra benefit.

NCCF: What are some missteps that can occur when clients make major gifts without the assistance of a knowledgeable advisor?

DV: Most people are concerned about the management of a large gift, especially if it’s given to a small organization–and for good reason. A small organization may not be able to afford an investment manager, leaving financial decisions to its Board. I have seen organizations make less than advantageous investment decisions. One charity put all of its money into an annuity and couldn’t touch it for seven years without a penalty; another received hundreds of thousands of unrestricted dollars through a donor’s will and spent all of it on one project instead of creating an endowment. I’ve also seen many private foundations created from estate plans in situations where they were not appropriate.

If an advisor has a client who expresses the desire to make a charitable gift and that advisor isn’t familiar with the various giving options, he or she should seek advice from someone who is—NCCF staff, the client’s accountant, or an attorney who practices tax law. I always recommend my clients work with a team of experts.

NCCF: What do you want other professional advisors to know about working with NCCF?

DV: NCCF is a facilitator for charitable giving within Northwest CT. I think people might assume that if you contact the Community Foundation there might be some pressure to make a gift. NCCF staff are happy to guide people in the appropriate direction for their giving. Community Foundations are great vehicles for accomplishing and facilitating clients’ charitable goals. People almost never initially say,“I’m going to make a gift to the Community Foundation,” but they have a certain area in mind, whether it’s specific organizations they’d like to support, a scholarship fund, or a cause, like the environment, a gift in memory of someone they love. They soon realize that NCCF is a great place to explore different options for achieving charitable goals.

Crowdfunding—Advising Clients

In the wake of natural disasters, national tragedies and medical misfortunes, donation-based crowdfunding campaigns seek to raise funds to help those in need. Online crowdfunding platforms make it possible for individuals to create campaigns within minutes of a disaster striking. By utilizing social media and other web-based platforms, campaign organizers are able to publicize their campaigns and collect thousands of dollars in donations for their causes.

Crowdfunding as a fundraising method has sky rocketed in popularity in recent years. A 2016 study from the Pew Research Center found that 22% of American adults surveyed had contributed to a crowdfunding campaign. Yet, despite this rise in popularity, there is little to no guidance for donors and advisors regarding the tax consequences of making donations to non-qualified charitable crowdfunding campaigns. The IRS has not released guidelines for these types of donations, leaving advisors to rely on traditional tax concepts to interpret how transfers to crowdfunding campaigns should be treated for tax purposes.

This article will examine donation-based crowdfunding and shed light on several issues for advisors to consider. Along with income and gift tax implications, there are also practical considerations that must be taken into account. These considerations include accountability for funds raised and whether donations will help—or hinder—the ultimate beneficiary of the campaign funds. By understanding the potential issues that exist in the murky waters of donation-based crowdfunding, advisors will be better prepared to work alongside their clients in order to guard against unwelcome and unexpected tax consequences in the future.

Crowdfunding is the practice of funding a project, charitable campaign, personal campaign or commercial venture by raising money from large numbers of individuals through a variety of online platforms. There are various types of crowdfunding, including donation-based, reward-based, equity-based and debt-based crowdfunding. This article will focus on donation-based crowdfunding, where individuals give money for a cause, project or person without receiving anything in return.

There are numerous crowdfunding platforms that serve as webhosts for individuals to launch their crowdfunding campaigns. GoFundMe is one of the leading donation-based crowdfunding platforms, with over $5 billion raised since its launch in 2010. Crowdfunding platforms, like GoFundMe, serve as the web host for the campaign, manage donations and track the campaign's progress.

Individuals who are not affiliated with qualified charities can set up crowdfunding websites to raise money for a variety of needs, including funeral costs, hospital bills, housing costs and adoption fees. Crowdfunding campaigns are also often sparked by the occurrence of national tragedies. Numerous campaigns were launched to help victims of the Las Vegas shootings, California wildfires and Hurricane Harvey. These campaigns gain attention by being shared across social media platforms and are often set up to benefit a friend or relative in need. One of the largest crowdfunding campaigns was set up to help victims of the Las Vegas shooting in October 2017. The campaign raised more than $10.8 million in its first 15 days.

Qualified Sec. 501(c)(3) charities are also entering into the crowdfunding arena. By creating crowdfunding pages, charitable organizations are able to appeal to a diverse field of donors and promote their charitable causes. In other instances, qualified public charities have partnered with existing crowdfunding campaigns. It is important to note, however, that some crowdfunding platforms charge a "platform fee" to public charities that use their websites. Thus, if an individual is considering giving to a qualified public charity's crowdfunding campaign, he or she may want to research the crowdfunding platform to see if it assesses a fee on public charities. If so, it may be preferable to give directly to the public charity itself in order to avoid reducing the total amount transferred to the charitable cause.

Is the Donation Tax Deductible?

The IRS permits taxpayers who contribute to qualified charitable organizations, as defined in Sec. 170, to deduct their contributions. Therefore, donors who give directly to public charities are accustomed to receiving charitable income tax deductions for their gifts.

What happens, however, when an individual makes a donation to a crowdfunding campaign? Is that contribution deductible? The answer is — it depends. If the crowdfunding campaign is run by a qualified, 501(c)(3) organization, then the contribution may be deductible. If the campaign is organized and run by an individual or a group that has not received tax-exempt status from the IRS and is not a qualified charitable organization, then the donation will not be deductible.

How can individuals tell whether or not their contributions to a crowdfunding campaign are going directly to a charitable organization? Some crowdfunding platforms will clearly label the campaign as one that is benefiting a qualified, or "certified," public charity. Alternatively, the organization itself will typically make it clear if it has tax-exempt status. In addition, advisors can urge their clients to look up the name of the organization on the IRS's "Tax Exempt Organization Search" tool on

In general, as a rule of thumb, if a crowdfunding campaign's website does not clearly indicate that donations are being made to a qualified charity, then it is unlikely that contributions will be tax deductible. In addition, if the campaign is raising funds for a specific individual, rather than the general public, then donations are not likely to be deductible. See PLR 201701021. This is because gifts to public charities must be made either "to" or "for the use of" the charitable organization in order to be deductible. A donation made to a qualified charity to benefit a specific individual is not deductible, regardless of how deserving that person may be. As such, if a crowdfunding campaign is requesting donations to pay for a specific individual's medical costs, rebuild a particular family's home or cover an individual's funerals costs, then those donations will not be deductible charitable contributions.

Becca was heartbroken after seeing television coverage of the most recent wildfires spreading across California. She wanted to make a contribution to the cause and discussed her options during her monthly meeting with her advisor, Garrett. Becca mentioned that she saw a Facebook post for a crowdfunding campaign that was established to help rebuild a family's home that had been destroyed by a wildfire. Garrett sat down with Becca to take a look at the campaign's website. After reviewing the campaign's information, it was clear that the campaign was not being organized by an exempt, qualified charitable organization because the funds raised would be going to only one family in particular. Upon closer examination, it was evident that the campaign was organized by a family member rather than a qualified charity. As such, Garrett suggested that they conduct more research to identify an exempt charitable organization providing similar support to affected families in the area. A simple internet search provided plenty of options and qualified organizations for Becca to choose from. Becca decided to make a contribution to a tax-exempt organization that will help to rebuild homes in the aftermath of the wildfires. As an added bonus, Becca will be entitled a charitable income tax deduction for her donation.

Is the Donation a Taxable Gift?

For donations to crowdfunding campaigns that are not organized by qualified charities, there is uncertainty regarding whether the donor may be required to report a taxable gift when he or she transfers funds to a crowdfunding campaign. In general, when an individual transfers funds or property to another individual, he or she may be required to file a Form 709 gift tax return. The annual gift tax exclusion allows individuals to transfer up to $15,000 per person, in 2018, without filing a gift tax return. For the annual exclusion to apply, the transfer must be considered a completed, present interest gift. Sec. 2503(b). This means that the gift recipient must have immediate use, possession or enjoyment of the property or income. Reg. 25.2503-3(b).

Gift tax issues arise in the crowdfunding arena where a campaign is organized not by a public charity but by an individual or group on behalf of an individual or group of individuals. This is because transfers to public charities qualify for an unlimited charitable gift tax deduction. Alternatively, if a donor transfers funds to a campaign that is raising money to cover costs of a child's medical bills, the donor has technically has made a taxable gift and may have to file Form 709. If the donation is less than $15,000, the donor may be able to argue that the transfer qualifies for the annual exclusion. However, under certain circumstances, that argument may fail to persuade the IRS.

Is the Donation a Completed Gift?

As stated above, the gift tax exclusion applies if the gift has been completed. Regulation 25.2511-2(b) explains that a gift is not complete if the donor reserves the power to revest the beneficial title to the property in himself. For crowdfunding sites, if the donor is able to claim a refund for his or her donation, is the transfer an incomplete gift for gift tax purposes? Alternatively, is the gift incomplete until the funds are distributed from the campaign to the beneficiary or cause?

The IRS has not provided a definitive answer to questions regarding the gift tax implications for contributions to donation-based crowdfunding campaigns. The only guidance that the IRS has provided in the area of crowdfunding was in Information Letter 2016-0036. This letter, however, focused not on donation-based crowdfunding but on reward and equity-based crowdfunding. As such, advisors must look to established gift tax principles to guide clients who plan to make contributions to an independent crowdfunding campaign. Advisors counseling clients through the donation process should review the crowdfunding site's terms of service, along with the terms of the payment processor for the site. In addition, the terms may be subject to state-specific laws and, as such, the controlling state's laws should also be considered.

Is the Donation a Present Interest Gift?

If the donation is determined to be a completed gift, then the next inquiry for the donor and advisor is whether the gift qualifies for the annual exclusion as a present interest gift. If the donation is going to benefit a large number of potential recipients, who cannot be presently determined, then the donation may not qualify as a present interest gift. Reg. 25.2503-3. In addition, if the campaign organizer is holding the donations in trust for the ultimate recipient, then the gift may not qualify as a present interest gift until the recipient has the right to the immediate use, possession or enjoyment of the funds. Reg. 25.2503-3(b).

In these situations, advisors should talk to the campaign organizer. If the recipient has the ability to withdraw the funds immediately, then the donation may qualify as a present interest gift under Sec. 2503. This could be accomplished by attaching a Crummey power to the trust, which would provide the recipient the right to withdraw the donor's gift from the trust for a limited period of time. See Crummey v. Commissioner, 397 F.2d 82 (9th Cir. 1968). Do note, however, that if the trust is set up as a special needs trust, giving the beneficiary the right to withdraw the transferred funds could jeopardize the purpose of the special needs trust and put the beneficiary's needs-based government assistance at risk.

Because of the uncertainty in this area, guidance from the IRS is needed to clarify the gift tax implications for donors giving to crowdfunding campaigns. In the meantime, advisors should educate their donors on these issues and help steer them in the right direction. If the donor is worried about exceeding his or her lifetime exemption amount, it may be preferable to give directly to a public charity to avoid any gift tax questions or unforeseen consequences. By giving directly to a public charity, not only will the donor not have to file a Form 709 gift tax return, the donor will be entitled to a charitable income tax deduction for the amount of the gift.

Will the Donation Jeopardize the Recipient's Needs-Based Benefits?

For those receiving needs-based government assistance, like Medicaid, Supplemental Security Income or other income-based support, receiving a large sum of money through a crowdfunding campaign could jeopardize important benefits. Even though the funds received through a crowdfunding campaign are considered gifts rather than taxable income to the beneficiary, for purposes of qualifying for certain government assistance, the beneficiary's resources as a whole—not just the beneficiary's taxable income—are taken into account.

For example, to be eligible to receive Supplemental Security Income (SSI), an individual's countable resources cannot exceed $2,000 (or $3,000 for a couple). For purposes of SSI, countable resources include, cash, stocks, bonds, real estate (other than the individual's residence), life insurance and other deemed resources. Thus, if the beneficiary of a crowdfunding campaign receives a large sum of cash or property, then he or she could be at risk of losing needs-based government assistance.

Because of these concerns, advisors should encourage clients who are considering giving to a crowdfunding campaign to contact the campaign organizer to ensure that the donation will not do more harm than good by putting the campaign recipient's government benefits at risk. One way to safeguard the donations is to ensure that the funds raised are not deemed the property of the campaign recipient. This may be accomplished by channeling the donations to a carefully drafted special needs trust. By sending the funds directly to a special needs trust, the recipient's benefits may be protected and the donations used to pay for costs that Medicaid and other needs-based benefit programs will not cover. (Note, however, that if a donor makes a contribution to a special needs trust, this may require the filing of a Form 709 gift tax return, since the contribution will not be a present interest gift for purposes of the gift tax annual exclusion amount. See the above present interest gift tax discussion for more information).

Will the Funds be used for the Campaign's Stated Purpose?

In addition to the tax implications and uncertainties surrounding crowdfunding donations, there are other potential issues to consider. When donors make gifts to crowdfunding campaigns that are not created by qualified charities, they run the risk that their donations will not be used as intended. Unlike qualified public charities, which must submit annual filings to the IRS and are subject to oversight by regulators and boards of directors, independent crowdfunding campaigns are not subject to government regulation. The terms of GoFundMe's website warn donors that "All Donations are at [their] own risk" and that it assumes "no responsibility to verify whether the Donations are used in accordance with any applicable laws."

While many crowdfunding platforms have procedures in place to guard against misuse and fraud, with the number of crowdfunding campaigns increasing each year, there have been numerous reported instances of scammers using crowdfunding pages to tug on the public's heart strings in order to unlawfully acquire large sums of cash. For example, in 2015 a thief set up a crowdfunding campaign to pay for the funeral of a Fayetteville, NC family killed in a house fire, when, in reality, the fire and the family did not exist. In another instance, a Brighton, MI resident falsely claimed to be suffering from stage-four breast cancer and raised more than $31,000 from nearly 400 people using a crowdfunding website. In other instances, criminals have claimed to be raising funds for real events and individuals but never transferred the funds to the specified person or cause. While sometimes the scammers are caught, in other instances they are able to take off with thousands of dollars.

It is important to note, however, that the majority of crowdfunding campaigns are organized for legitimate purposes. GoFundMe estimates that fraudulent campaigns make up less than one tenth of one percent of its campaigns. Still, advisors should counsel their clients to do their research and exercise caution before handing over a donation to a crowdfunding campaign in order to ensure that the funds will be used exactly as intended. Clients should be encouraged to thoroughly research the campaign and cause or, alternatively, only give to a campaign if they know the organizer or organization. Alternatively, donors could choose to donate directly to a qualified public charity instead. This may offer clients peace of mind in knowing that appropriate safeguards and regulations are in place to protect their donations.

With the number of donation-based crowdfunding campaigns increasing each day, it is important that advisors educate their clients on the possible implications of their contributions. Without firm guidance from the IRS or federal legislation stating otherwise, it can be assumed that contributions to crowdfunding campaigns that are not organized by public charities may be considered reportable gifts for gift tax purposes. For clients with taxable estates, this is an important consideration and topic of discussion.

Additionally, clients may incorrectly assume that every donation to a crowdfunding campaign qualifies for a charitable income tax deduction. By explaining that a charitable income tax deduction only applies if the campaign is organized by a qualified tax-exempt charity, advisors can ensure that their clients are giving in a way that meets both their financial and philanthropic goals. Often times, it may be preferable to give directly to a charitable organization in order to ensure that the client's donation qualifies for a charitable deduction and that it will be used for the organization's stated purpose. Because public charities are subject to government oversight and regulation, not only does the donor receive comfort in knowing that the funds are safeguarded but he or she can also be assured that the beneficiary's needs-based government assistance will not be jeopardized.

While a donation to a crowdfunding campaign may be motivated by noble and altruistic intentions, it is important that donors know to exercise caution before handing over a large sum to a crowdfunding campaign. Not only is the campaign's legitimacy something that should be considered, but the tax treatment of the donation should also be on the forefront of the donor's mind. Until further guidance is provided by Congress or the IRS, advisors should discuss the issues raised in this article with their clients in order to prevent unintended tax and legal consequences. With an understanding of the issues involved with donation-based crowd funding, advisors can arm their clients with knowledge that will protect their best interests and fulfill their charitable and financial objectives.

IRS Tax Treatment of Cryptocurrency

Cryptocurrency is an encrypted form of digital virtual currency which has grown in prominence, as its most popular variant, Bitcoin, has exploded in value in recent years. With increased popularity comes increased curiosity as to the tax treatment of cryptocurrency. Many cryptocurrency owners have held onto this unique asset for a number of years, amassing enormous growth. Programming changes have left many cryptocurrency owners holding several forms of digital assets. These owners now wonder how their digital currency will be taxed if they transfer it and whether charitable solutions exist similar to those for gifts of cash or appreciated property.

The IRS addressed several questions related to the taxability of virtual currency when it issued Notice 2014-21. However, certain questions remain unaddressed by the Service. This article will explore the basic function of cryptocurrency and the tax treatment surrounding transfers of cryptocurrency.

What is Cryptocurrency?

While Bitcoin may, at times, seem to be virtually synonymous with "cryptocurrency," it is merely the most prominent member of its class. Other cryptocurrencies, such as Litecoin, Ethereum and Ripple have become major players in the world of virtual currency. The rise in popularity of cryptocurrency has led to questions about what it is and how (or even whether) it is taxed.

In 2014, the IRS took a first step toward addressing the taxation issues surrounding virtual currencies. In Notice 2014-21, the IRS defines virtual currency as "a digital representation of value that functions as a medium of exchange, a unit of account, and/or a store of value." Virtual currency has been touted in recent years as a potential replacement for standard currency. Whereas standard currency is issued and regulated by a governmental entity, virtual currency is usually decentralized and is not issued by any government.

Cryptocurrency is a subset of virtual currency. It is distinguished by its use of cryptography for security. Cryptocurrency transactions are recorded on a digital ledger known as a blockchain. As its name suggests, each transaction for the cryptocurrency creates a new block in a chain of transactions. The ledger is stored in various places and contains cryptographic identifiers, known as hashes. Each block in the chain contains its own hash and that of the previous block. The presence of these identifiers and the wide distribution of the ledger greatly reduce the blockchain's susceptibility to tampering.

How is Cryptocurrency Treated by the IRS?

According to Notice 2014-21, cryptocurrency is treated as property. A taxpayer who acquires virtual currency as a payment for goods or services has a cost basis equal to the fair market value of that virtual currency on the date of transfer. Any gain or loss related to the sale of cryptocurrency is treated the same as a sale of other appreciated or depreciated property.

The type of gain or loss the taxpayer must recognize upon disposition of virtual currency "depends on whether the virtual currency is a capital asset in the hands of the taxpayer." Notice 2014-21 notes the difference in the tax treatment of capital assets, such as stocks and bonds, from non-capital assets, such as inventory. Therefore, if the taxpayer holds the virtual currency in a manner consistent with the capital asset rules, it will be taxed in the same manner as a capital asset upon disposition.

Bitcoin, for example, was created in 2009 using an algorithm that limits the total number of possible Bitcoins in existence to 21 million. New Bitcoins are discovered through a process called mining. The mining process involves the use of particular software to solve a complex equation. As more Bitcoins are discovered, the difficulty of the equations increases. In Notice 2014-21, the IRS explained that a taxpayer who has mined Bitcoins or other virtual currency has generated ordinary income through the mining activity.

If an individual holds Bitcoins or other virtual currency as a dealer-one who holds it as inventory-any increase in the value of the virtual currency will be treated as ordinary income. In contrast, a non-dealer individual investor will hold the virtual currency as a capital asset. The taxpayer will realize capital gains upon sale of the property.

Example 1
Amy operated a successful Manhattan restaurant. One day, in the summer of 2010, she received an odd request from a potential customer. He called in a takeout order and was interested in paying with Bitcoin. Having heard of Bitcoin, and willing to take a risk on a small order, Amy accepted the order and received payment of 5,000 Bitcoins in exchange for the entrée. On the date the purchase was made, the fair market value of 5,000 Bitcoins was $20.

Although amused by the transaction, Amy filed away her receipt and forgot about her modest Bitcoin holding until a news article discussing the rising value of cryptocurrencies caught her eye three years later. After digging up her information, Amy was elated to find that her 5,000 Bitcoins were now worth $3,000,000. Amy decided that she did not want to risk a tremendous loss in value by holding onto the Bitcoins for any longer. She quickly decided to sell the Bitcoins, putting some of the cash toward paying off loans and using the rest to expand and improve her restaurant.

Having sold the Bitcoins for $3,000,000, with a cost basis of $20, Amy incurred a capital gain of $2,999,980. At the top capital gains rate of 23.8%, Amy had a tax bill of $713,995 from the sale. She therefore received $2,286,005 from the sale of her once $20 asset.

Using Cryptocurrency to Fund a Charitable Gift

Because holders of virtual currency face the same capital gains tax ramifications as owners of other appreciated assets, many will find similar charitable solutions to be attractive. Outright gifts, charitable gift annuities and charitable remainder trusts are all potential solutions to the capital gains tax problem. As with other gifts of appreciated property, it is important to keep in mind that the donor will need a qualified appraisal in order to substantiate the value of a donation of virtual currency in excess of $5,000 in value.

Advisors and donors should be mindful that the relative novelty of cryptocurrency could be an obstacle in circumstances where owners wish to transfer ownership of these digital assets to charitable organizations. While there are many organizations that have begun accepting cryptocurrency donations, there are many others that have not yet tested the waters. For these organizations, charitable gifts that require a transfer of legal ownership directly to the charity may not be an option.

One alternative solution is for the owner to establish a charitable remainder trust, naming the charity as the beneficiary of the trust. The owner then transfers units of cryptocurrency to the trust, which may then sell the cryptocurrency and reinvest. This generates both a payout stream and a charitable deduction for the donor and a residual benefit for the charity, without the charity having to take ownership and possession of the cryptocurrency.

Example 2
Instead of selling her 5,000 Bitcoin, Amy's tax advisor recommends that she consider creating a charitable remainder unitrust with a portion of her cryptocurrency and sell a portion. This strategy will allow her to offset a portion of her capital gains tax from the sale of her Bitcoin holding with a charitable deduction. She would receive an immediate lump sum of cash from the sale and lifetime payouts from the unitrust. Working with her advisor, Amy determines that she can zero out the taxation on the sale of $1,120,500 worth of Bitcoin if she uses $1,879,500 to fund a one-life charitable remainder unitrust. She will bypass a portion of her capital gains by funding the unitrust and will receive an initial annual payout of $93,975, which could increase over time, depending on the performance of the trust's investments. Given her age at the time the trust is created, she may have 30 years of payouts, potentially totaling $3,263,000.

Determining the capital gains allocated to a cryptocurrency can be relatively straightforward. For cryptocurrency acquired by purchase, the owner's cost basis is equal to the amount paid for the property. The cost basis of a cryptocurrency received as a payment for goods and services is the fair market value of the cryptocurrency on the date of receipt. However, there are other ways a taxpayer may acquire cryptocurrency, which can make the valuation process more difficult.

Cryptocurrency Forks

When a software coding change is proposed to a cryptocurrency, the change will bring about what is called a fork. The fork creates an alternate path in the blockchain. A fork may either be a soft fork or a hard fork. A soft fork will result in a change to the makeup of all future blocks in the blockchain. This might occur if there is agreement as to how the blockchain should be modified. While there is a change to all future blocks in the chain, no new asset is created in the hands of the owner of the virtual currency.

A hard fork, on the other hand, creates two divergent paths for the blockchain, resulting in completely separate cryptocurrencies. Anyone who owns units of a particular cryptocurrency prior to a hard fork will continue to own the same number of units of that cryptocurrency, along with an identical number of units of the new cryptocurrency.

Bitcoin, for example, has experienced multiple hard forks. On August 1, 2017, Bitcoin owners received the newly created Bitcoin Cash in an amount equal to the number of Bitcoins that the owner originally held. Similar hard forks occurred on October 24, 2017 and February 28, 2018, creating Bitcoin Gold and Bitcoin Private. Anyone who held units of Bitcoin prior to August 1, 2017 and did not dispose of them prior to March of 2018, subsequently held an equal number of units of Bitcoin, Bitcoin Cash, Bitcoin Gold and Bitcoin Private. Hard forks have the potential to generate extra value for the owner of cryptocurrency, since the holder of one unit of a particular cryptocurrency can eventually become the holder of units of multiple distinct and separate cryptocurrencies following a series of hard forks. However, this increase in value to the owner depends on the ability of the new cryptocurrency to gain traction in the market. If the new cryptocurrency is not well-received, the owner may end up with little or no increased value.

The pressing question for the owner of cryptocurrency acquired through a hard fork is whether the new property is treated as taxable income. Under IRC Sec. 61, gross income is defined as "all income from whatever source derived." Absent specific guidance from the IRS to the contrary, the most conservative approach is to treat the new cryptocurrency as ordinary income on the date it is created. Under this theory, the cryptocurrency owner will realize ordinary income for the year in which the hard fork occurred, equal to the new cryptocurrency's fair market value on the date of the fork.

Example 3
Tim purchased three units of the latest and greatest cryptocurrency, OldCoin, a few years back for a total of $300 as a long-term investment. The value of Tim's three units of OldCoin has reached $8,200. Tim is aware that OldCoin experienced a hard fork on the first day of December and decided to meet with his advisor to determine the effect of the hard fork on his small cryptocurrency investment. Tim's advisor explains that, due to the hard fork, Tim now owns three units of OldCoin and three units of NewCoin. The advisor then tells Tim that he may need to report the value of the new cryptocurrency as ordinary income on his tax return. Tim and his advisor determine that each unit has a fair market value of $250 on the date of the hard fork. Because Tim holds three units of an entirely new asset at $250 per unit, he will recognize an additional $750 in income for the year. Tim accordingly reports the small bump in income for his 2017 taxes.

Tim decides to hold onto the three OldCoins and three NewCoins for five years, at which point his original three units have appreciated to a total value of $20,000. His newer cryptocurrency has reached a fair market value of $10,000. Eager to cash in on his modest $300 investment, Tim decides to sell all six of his cryptocurrency units for a total of $30,000. He returns to his advisor and asks what the tax consequences of the sale will be. Because Tim has held the cryptocurrency for more than one year, his advisor explains that Tim will be taxed at long-term capital gains rates for the sale. Tim's basis in his OldCoin units will be the $300 that he originally invested. Therefore, he will have $19,700 in taxable capital gains upon the sale. His NewCoin units have a cost basis of $750, with capital gains of $9,250.

In a letter dated March 19, 2018, the American Bar Association (ABA) Section of Taxation submitted comments to IRS Acting Commissioner David Kautter, seeking updated IRS guidance on cryptocurrencies and offering recommendations, specifically related to the tax treatment of cryptocurrency hard forks. Among its suggestions, the ABA recommended that the IRS create a temporary safe harbor for cryptocurrency holders who experienced a hard fork in 2017. The ABA Section of Taxation cited "difficult timing and valuation issues" as the impetus for the suggested safe harbor rule. The date on which an owner takes possession of a unit of cryptocurrency has been the subject of debate and may depend on whether the owner holds the unit directly or through an intermediary. A similar difficulty arises as to the valuation of the new cryptocurrency, as there are various online exchanges, each of which may provide a different estimated value on the starting date.

The ABA's proposed temporary rule would treat a hard fork as a taxable event whereby the owner of the original unit of cryptocurrency would realize taxable income with a zero basis in the newly created unit of cryptocurrency. The taxpayer would then have a capital asset that will have capital gain treatment after the owner has held it for more than one year.

Example 4
Instead of treating the NewCoin as an accession to an additional $750 of wealth in the tax year, Tim and his advisor decide to take a more aggressive approach and claim that Tim's three units of NewCoin had a zero basis on the date of the hard fork. Therefore, his adjusted gross income for the year is not affected by the hard fork. When Tim sells his NewCoin holdings five years later for $10,000, however, he will recognize $10,000 in capital gains.

The ABA's request for updated IRS guidance is just one of many attempts to clarify the tax treatment of cryptocurrency. The IRS has not responded to the ABA's request, or other similar requests for guidance, choosing instead to remain silent in the years following the release of Notice 2014-21. Professional advisors, therefore, are left to determine the proper treatment of their clients' cryptocurrencies by applying general principles of law, despite the fact that those general principles may not be directly on point for this relatively new type of asset.

Cryptocurrency is a new and constantly developing facet of the 21st century economy. While the IRS has provided certain guidelines as to its tax treatment, and general principles of law can be used to fill in certain gaps, the ever-evolving nature of this new type of property means that additional guidance will be required in the years to come. Nevertheless, appreciated cryptocurrency may be a good asset to use to fund a charitable gift, as the owner may receive a tax deduction and be able to bypass capital gains on the cryptocurrency.

The current limited nature of the IRS's guidance regarding the tax treatment of cryptocurrencies affects owners, tax professionals and charitable gift planners, causing uncertainty over the value of potential donors' cost basis and capital gains in their cryptocurrency holdings. Cryptocurrency owners should seek guidance from their professional advisors prior to acquiring, selling or donating units of cryptocurrency. Owners should also beware that they may be deemed to have acquired new cryptocurrency during a given year, thus increasing their adjusted gross incomes, due to a hard fork.

In the News: Charitable Gifts of Intellectual Property Assets

Intellectual property assets are intangible products or creations of the mind that may receive protection under the law. The most common types of intellectual property (IP) that a client might consider gifting to charity include copyrights, trademarks and patents. While making a charitable gift an IP asset can provide a client with tax benefits, the legal complexities that surround these types of gifts necessitate a deeper understanding of these assets prior to making a charitable transfer. As such, it is crucial that advisors have a firm grasp on how these gifts operate in order to best serve their clients' needs and objectives.

This article will explain the basic rules surrounding charitable gifts of IP assets and the opportunities that exist for IP asset owners. It will shed light on the tax benefits associated with charitable gifts of IP and identify practical issues for clients who are considering charitable transfers of IP assets. By understanding the rules and nuances that apply to charitable gifts of IP assets, advisors will be better equipped to guide clients in the right direction and accomplish their goals in a tax-efficient manner.

Common Types of Intellectual Property Gifts


A copyright is an intangible property right that protects original works, including literary, artistic, dramatic, pictorial, graphic, audio, sculptural, audio-visual and architectural works. The owner of a copyright has the exclusive right to reproduce the copyrighted work, to prepare derivative works, to distribute copies of the copyrighted work for sale or lease, to perform the copyrighted work publicly or to publicly display the copyrighted work. A copyright is a property right that is separate from the copyrighted work. For example, an individual might own the copyright to a manuscript and a different person may own the manuscript itself.


A trademark is a word, phrase, symbol or design that is used to identify a maker of a commodity offered for sale. Common examples include company names, logos, taglines and product names. However, a trademark could also be a particular shape, sound, color or scent that is used to identify or distinguish a particular commodity. A trademark can be registered with the United States Patent and Trademark Office (USPTO). Both registered and unregistered trademarks reflect the right to legitimate use of the mark, but only a registered trademark gives the owner the exclusive right to use the mark nationwide on, or in connection with, the goods and/or services listed in the registration.


A patent is an intangible property right that protects an invention. The owner of a patent has the right to exclude others from making, using or selling the patented invention for a number of years. In the United States, the USPTO grants patents to inventors after the inventor publicly discloses the invention by filing a patent application. The most common type of patent is a utility patent, which is granted to an individual who discovers or invents "any new and useful process, machine, article of manufacture or composition of matter, or any new and useful improvement thereof." 35 U.S.C. Sec. 101.

General Rule for Charitable Gifts of Intellectual Property

A donor who makes a charitable gift of an IP asset is entitled to a deduction that is equal to the lesser of the property's basis or fair market value. IP assets are considered capital assets if the taxpayer purchased or inherited the asset. As such, the deduction for charitable gifts of IP assets will be limited to 30% of the donor's adjusted gross income (AGI) in the year of the gift with the excess carried forward up to five additional years.

After the gift is made, the donor may be able to claim additional deductions based on the income produced by the IP asset. Under Sec. 170(m) of the Internal Revenue Code, the donor may be entitled to additional deductions for the percentage of qualified donee income (QDI) derived by the charity from the IP asset. QDI includes any net income received by or accrued to the charity allocable to the IP itself, including royalties or other net income. I.R.C. Sec. 170(m)(3). The deductions may be taken for up to 10 years. Sec. 170(m)(5).

In order to take advantage of these additional deductions, the donor must provide written notice to the charity at the time of the contribution that the gift is to be treated as a qualified intellectual property contribution for purposes of Sec.170(m)(5) and Sec. 6050L. Sec. 170(m)(8)(b). Each year, the charity will be required to report the amount of qualified donee income (QDI) on Form 8899, Notice of Income from Donated Intellectual Property.

The amount of the QDI deductions is determined on a sliding percentage scale basis and is limited to 10 years beginning on the date of the contribution. The deduction is only available for QDI in excess of the donor's original deduction. The deduction amount starts at 100% of the QDI in excess of the donor's original deduction in year 1 and declines to 20% by year 10. Sec. 170(m)(7)

Tax YearDeductible Percentage

Example 1:
Rose invented and obtained a patent for a state-of-the-art inflatable life raft that, despite its compact size, is able to carry twice the number of people as current inflatable models. Her $100,000 cost basis consists of development costs, including material and labor. Experts predict there will be high demand for Rose's patented device and assign a fair market value of $1,000,000 to the patent and device. Rose would like to make a gift of the patent and her rights to the life raft to her favorite charity. Her advisor informs her that, pursuant to Sec. 170(m), the patent is qualified intellectual property and, therefore, eligible for additional deductions after the gift. In order to receive these benefits, Rose's advisor assists her in putting together written notice to her favorite charity of her intention to treat the gift as a qualified intellectual property contribution.

In the year of her gift, Rose will claim a basis deduction of $100,000. The charity, in return, licenses the patent to a manufacturer. Two years later, her favorite charity is beginning to receive substantial royalties. Because the income is derived from the patent, Rose can claim additional charitable deductions. The patent earns $500,000 in year two, which exceeds her original deduction by $400,000. As such, the patent has produced $400,000 of QDI. Assuming that, following year two, the patent produces $100,000 of QDI each year, her deductions will be as follows:

Deductible %
Deduction Amount

The charity will be required to file Form 8899 each year to report the amount of QDI to the IRS and provide a copy to Rose to substantiate her deduction.

Creators of Copyrighted Works and Carry-over Basis Copyright Holders

Copyrights are not considered capital assets if they are owned by the individual who created the copyrighted property or received by an individual as a gift from the creator of the copyrighted property during life (i.e., someone who has received a "carry-over basis" from the creator). Sec. 1221(a)(3); Reg. 1.1221-1(c)(1). As such, these copyright gifts will be subject to the 50% (rather than 30%) AGI deduction limitation. Charitable deductions for gifts of copyrights held by a donor whose personal efforts created the property, or who has received a carry-over basis, will be limited to cost basis.

In addition, gifts of copyrights held by the creator (or a donor who received a carry-over basis from the creator) are not considered qualified intellectual property for purposes of additional QDI deductions under Sec. 170(m). As such, any royalties or net income received by the charity derived from the copyright cannot be deducted by the donor in future years.

Example 2:
Jack is an author of a copyrighted novel. He wants to gift his copyright and his novel to his favorite charity. Jack spent approximately $1,000 on legal fees and costs associated with registering and maintaining his copyright. Because he is the creator of the copyrighted work, his charitable income tax deduction for his gift will be limited to his basis, which in this instance is $1,000. Jack will not be able to claim deductions in future years for royalties that the charity derives from the novel. This is because the copyright is not qualified intellectual property since it was created through the personal efforts of Jack. As such, the total deduction that Jack will be able to claim is $1,000.

Recall that, whether the owner of a copyright can deduct QDI will depend on if the copyright is considered qualified intellectual property under Sec. 170(m). If the donor receives the copyright interest as a gift from the creator of the copyrighted work during life, then the donor will have a carry-over basis from the creator and, therefore, will not be able to deduct QDI. If, on the other hand, the donor inherited the copyright after the death of the creator, then the donor will not have a carry-over basis and will be able to deduct QDI.

Example 3:
Many years later — after authoring numerous best-sellers — Jack gifted one of his manuscripts (manuscript A) and its copyright to his cousin Molly. He also executed his will and provided that his brother, Fabrizo, would receive a manuscript (manuscript B) and its copyright upon Jack's death. Five years after Jack's death, Molly and Fabrizo decide to make charitable gifts of their manuscripts to Jack's favorite charity in his honor. Jack's original cost basis for both manuscripts was $1,000. Upon his death, the fair market value of each manuscript was $250,000.

Because Molly received the gift during Jack's life, her basis is Jack's original basis of $1,000. Therefore, she would receive a $1,000 deduction for her charitable gift. Because she has a carry-over basis from the manuscript's original creator, she will not be able to claim QDI deductions for future royalties received by the charity.

Because Fabrizo inherited the copyright and copyrighted work after Jack's death, his basis is equal to the fair market value of the copyright at Jack's death. Therefore, he will receive a $250,000 basis deduction for his charitable gift. In addition, because he does not have a carry-over basis, the copyright is qualified intellectual property. Therefore, Fabrizo will be able to deduct future royalties received by the charity as QDI.

Partial Interest Rule

Under Sec. 170(f)(3), a charitable deduction will not be allowed where a donor transfers less than his or her entire interest in the property. The partial interest rule may arise in a variety of circumstances related to gifts of IP assets. For example, a donor who owns both a copyright and the underlying copyrighted material cannot claim a charitable deduction if the donor gifts the copyright only and retains the copyrighted asset. The donor who owns both the copyright and copyrighted material must make gifts of both interests to claim a charitable deduction. If, however, the donor only owns the copyright and not the copyrighted work, then he or she could make a charitable gift of the copyright alone and receive a charitable deduction, since the copyright in that instance is the donor's entire interest in the property.

The partial interest rules also dictate that a donor cannot hold onto certain rights related to the IP asset. For example, a donor cannot make a charitable gift of a patent while retaining the right to manufacture the patented product. Nor could a donor make a gift of a trademark to charity but retain the right to prescribe the standard of quality of products or services sold under that trademark. In both instances, the donor would be giving a nondeductible partial interest in the IP asset.


Generally, a charitable gift of property over $5,000 in value will require a qualified appraisal. Reg.1.170A-13(c). However, donations of intellectual property are excluded from this requirement. See IRS Pub. 561 and IRS Form 8283 Instructions. The value of the IP gift will still need to be determined and recorded on Form 8283. As such, the question becomes: how is the value of the IP asset determined?

Typically, the charity will consult an intellectual property valuation professional. Most often, the valuator will determine the IP's fair market value by using an income-based approach. This method forecasts future financial earnings results based on historical financial data, market trends and comparable income for similar assets. Taking these, and other data, into consideration, the valuator will forecast the present value of the IP asset's future income in determining the fair market value of the IP asset.

Unrelated Business Income Tax

Under Sec. 511, the unrelated business income of an exempt organization is subject to tax. Unrelated business taxable income is defined as the gross income derived by any organization from any "unrelated trade or business" regularly carried on by the organization, less the allowable deductions directly connected with the conduct of that trade or business. Sec. 512(a)(1). In the context of IP assets, the question arises whether income produced by a donated IP asset is classified as unrelated business income.

Luckily, under Sec. 512(b)(2) royalties are classified as passive income and therefore not subject to unrelated business income tax (UBIT), except to the extent that the asset is debt financed. The definition of a royalty is exceedingly broad and extends to virtually all payments for the right to use intellectual property. Sec. 1.512(b)-1(b).

Charitable organizations should be cautious, however, before involving themselves in the IP's underlying trade or business. While receipt of passive royalty income is excluded from UBIT, actively participating in, and performing services for, an unrelated trade or business is not. Thus, if income can be traced to services performed, rather than the royalty income, the charity could be opening itself up to risk and potential UBIT consequences. Sierra Club, Inc. v. Commissioner, 86 F.3d 1526 (9th Cir. 1996). As such, organizations should exercise caution when executing royalty agreements in connection to donated IP assets.


While a charitable gift of an IP asset can be an effective way to secure tax benefits and accomplish a client's charitable goals, IP owners and their advisors should work together to ensure that the charitable transfer is accomplished in a tax-efficient manner in order to avoid potential issues that can arise. IP owners and their advisors should consider the value of the owners' cost basis relative to the IP asset's fair market value, as well as the estimated value and timing of the asset's revenue stream in future years. These considerations will help the client to arrive at a charitable strategy that will meet personal and financial objectives. While there are many complexities in this area, charitable gifts of IP assets should not be overlooked, as the benefits and opportunities associated with these gifts can often outweigh potential hurdles in the planning process.

Developments with Donor-Advised Funds

Individuals concerned with tax planning often include charitable giving as an important element of their planning strategies. In addition to the satisfaction of knowing that they have contributed to important causes, these taxpayers may also enjoy the charitable income tax deduction that comes with a gift to charity. For many individuals, regular annual outright gifts have satisfied their goals. Under certain circumstances, taxpayers may find that their giving strategies over recent years will no longer produce their desired results. These clients may benefit from a giving strategy that allows them to make a large donation up front and the flexibility to direct the payouts over a number of years.

This article will explore the basic rules related to donor advised funds (DAFs), specifically those regarding charitable deductions and benefits to donors and their family members. It will also discuss recent developments in tax law and policy directly affecting DAFs. Finally, the article will cover scenarios in which the recent changes may encourage taxpayers to consider DAF donations.

DAF Basics

Under Sec. 4966(d)(2)(A), a donor advised fund must be (i) "separately identified by reference to contributions of a donor or donors" and (ii) "owned and controlled by a sponsoring charity." In addition, "the donor must have or reasonably expect to have advisory privileges with respect to the distribution or investment of the amounts in the account." Funds or accounts that make distributions to only a single organization are not considered donor advised funds. Sec. 4966(d)(2)(B).

For the fund to be separately identified, it is usually created in the name of a specific donor. The donor can then add to his or her own fund at any time. If a separate account is not created for each donor, then the organization should have a mechanism in place to track the contributions of each donor to the fund.

A charitable organization must have complete ownership of and control over the fund. Sec. 4966(d)(1). The owner of the fund, known as the "sponsoring organization," must be a 501(c)(3) public charity and may not be a private foundation. However, the donor must also reasonably expect to have advisory privileges regarding both investments and distributions. Therefore, a DAF must be clearly owned by a charitable organization and also allow the donor to provide input as to when and where distributions are made.

Normally, the sponsoring organization will abide by the wishes of the donor. However, the donor does relinquish title and control over the funding asset(s) on the date the DAF is funded. Therefore, the sponsoring organization is not bound to follow the donor's advice. If, for instance, the donor advises a gift that is impermissible, either under IRS rules or the sponsoring charity's mission or standards, the sponsoring charity may refuse to make the distribution. Normally, sponsoring organizations will make their best efforts to follow their donors' wishes.

Because DAFs are owned and controlled by Sec. 501(c)(3) public charities, taxpayers may deduct donations in the same way that they would for other gifts to public charities. Donors' deductions are limited to 60% of adjusted gross income (AGI) per year on gifts of cash and 30% of AGI for gifts of appreciated property held for more than one year.

The deduction is taken in the year that the DAF is funded. The donor does not have the option to delay taking a deduction until the DAF makes a distribution to charity. However, if the donor meets the deduction limits in the year the DAF is funded, he or she may carry the deduction forward for up to five additional years.

TCJA Changes and DAF Solutions

In December 2017, Congress passed the Tax Cuts and Jobs Act (TCJA). Among its many changes to U.S. tax law, the TCJA nearly doubled the standard deduction amount. For 2018, the standard deduction is $12,000 for individual taxpayers and $24,000 for married couples filing jointly. This has the likely effect of greatly curtailing the number of taxpayers who itemize their deductions. A vast number of taxpayers who previously itemized their deductions may instead be left with one option: take the standard deduction.

Example 1
Over the last five years, Darryl has given $10,000 annually to his local homeless shelter and $5,000 to his alma mater. He has a passion for helping care for the homeless and also wishes to do what he can to give back to the university he attended. He has also enjoyed the $15,000 charitable income tax deduction he has received each year. While meeting with his tax advisor regarding this year's tax situation, however, Darryl is dismayed to discover that even with his generous charitable giving, he and his wife Sue will be below the threshold for itemizing their taxes and will instead take the standard deduction for a married couple.

One potential solution to this problem is a gift to a donor advised fund. A taxpayer who might otherwise be disincentivized from making a charitable gift by the newly-doubled standard deduction may be attracted to the flexibility of donor advised fund giving. The taxpayer may find that he or she can continue to itemize by bundling several years' worth of charitable gifts into one year, exceeding the standard deduction threshold.

Example 2
In an attempt to maximize his tax deduction this year, Darryl asks his advisor if there are any alternative giving methods available. Darryl is pleased to hear his advisor offer a potential solution. Instead of giving $15,000 each year to charity, Darryl can bundle five years' worth of charitable gifts into one year. He decides to use $75,000 of stock to set up a donor advised fund. Darryl takes a deduction up to 30% of his adjusted gross income for the year. Darryl deducts $45,000 this year and then carries forward the remaining $30,000 deduction to next year. During each of the next five years, Darryl directs annual distributions of $10,000 to the homeless shelter and $5,000 to the university.

Excess Benefits

Donor advised funds are subject to the excess benefit transactions rules of Sec. 4958. An excess benefit transaction occurs when a charity engages in any transaction with a disqualified person whereby the disqualified person receives a direct or indirect benefit from the charity for which he or she did not pay and the value of the benefit exceeds the value of the consideration received. Any grant, loan or payment of compensation to a donor, donor advisor or a relative of the donor (hereinafter referred to as a "disqualified person") is an excess benefit transaction. Sec. 4958(c)(2). The disqualified person who receives the excess benefit will be assessed a tax equal to 25% of the excess benefit. If an organization manager knowingly assists in an excess benefit transaction, the manager will be taxed at 10% of the value of the excess benefit.

Incidental Benefits

Donor advised funds are prohibited from making distributions that benefit donors, their family members or an entity of which 35% or more is controlled by these individuals. Sec. 4967. These rules are similar to the private foundation "disqualified person" rules and are designed to minimize the potential for donors to abuse the DAF structure and receive inappropriate benefits. Any disqualified person with respect to the DAF who advises a distribution resulting in more than an incidental benefit to a disqualified person will be subject to an excise tax equal to 125% of the distribution. If the fund manager makes the distribution knowing that it would confer more than an incidental benefit on a disqualified person, the manager will be subject to a tax equal to 10% of the benefit.

For many years, the consensus among practitioners has been that the "incidental benefit" rules preclude distributions from DAFs to satisfy legally-binding pledges. A pledge is an agreement between an individual and a charity whereby the individual promises to donate a specific amount of money by a specific time. If there is consideration for the promise to pay, then the pledge may be legally-binding, depending on the governing state law. Once the donor satisfies his or her obligation to make the donation, the pledge has been fulfilled, releasing the donor from a legal obligation. The common understanding among tax professionals has been that this release of a legal obligation is more than a mere incidental benefit. Under this framework, a donor's request that the sponsoring organization make a distribution to a charity with which the donor has an outstanding legally-binding pledge would be taxable at 125% to the donor. If the fund manager is aware of the obligation, he or she would be subject to a 10% tax.

Example 3
Five years ago, Erin signed a binding pledge agreement with her local hospital foundation, promising to donate $5,000 each year for 10 years. Two years ago, while looking for an additional charitable deduction during a particularly successful year for her law practice, Erin donated $10,000 to a DAF. She liked that she could take an immediate deduction now and decide which charities will receive the money at a later date. Over the past several months, Erin's law practice has recently fallen on hard times, considerably tightening up her budget for the year. She would prefer to hold onto her hard-earned cash and advise the DAF to make this year's $5,000 distribution to the hospital foundation to satisfy her pledge. When Erin met with her tax professional, however, he advised her that she would face a substantial excise tax if she advised the sponsoring organization to fulfill this year's pledge amount. Rather than saving her some cash, the distribution could cost her an additional $6,250.

Updated Guidance

In Notice 2017-73, released in December 2017, the IRS announced its intention to develop proposed regulations and requested comments on several issues pertaining to donor advised funds. The Service provided a brief history of its approach toward DAFs, including Notice 2006-109, which provided temporary guidance on certain DAF questions and Notice 2007-21, which requested comments on IRS rules related to DAFs. The Service noted that several commenters requested IRS guidance on two specific issues. First, many commenters asked whether a distribution from a DAF to pay for tickets to a charity-sponsored event, such as a fundraiser, would result in more than an insubstantial benefit to the donor under Sec. 4967.Second, commenters inquired whether a DAF distribution that satisfies a donor's pledge would violate Sec. 4967.

Regarding the first question, the Service noted that commenters suggested that if a DAF distribution paid for only the deductible portion of the ticket, then an excess benefit has not occurred. Under this theory, if a DAF pays for only the fair market value portion of the ticket and the donor covers the excess cost, the donor's benefit is insubstantial.

Nevertheless, the Service disagreed with this theory and determined that a DAF's payment of part of the ticket price would relieve the donor of the obligation to pay the full ticket price. Thus, the IRS stated that the proposed regulations would conclude that a DAF distribution to pay for fundraiser tickets would result in more than an insubstantial benefit to the donor. The Service further noted that the distribution may violate both the Sec. 4967 "incidental benefit" rule and the Sec. 4958 "excess benefit transaction" rule.

The Service next addressed the question of whether DAF contributions can be used to satisfy donors' pledges. The Service began by pointing out that several commenters likened the Service's approach to DAF distributions to the Sec. 4941 prohibition against private foundations making grants to fulfill the legal obligations of disqualified persons. The Service then noted that with regard to pledges, the distinctions between legally-binding pledges and non-binding pledges (which it labeled "merely an indication of charitable intent") are often difficult for sponsoring organizations to determine. Therefore, the Service suggested a framework under which DAF distributions may be allowable to charitable organizations with which the donor has an outstanding pledge.

If the following three-prong test is satisfied, the donor will not be treated as having received more than an incidental benefit. First, the distribution from the sponsoring organization must make no reference to the existence of a pledge. Second, the donor may not receive any other benefit that is more than incidental. Third, the donor must not attempt to claim a charitable deduction for the distribution. If all three of the above requirements are met, a contribution made in fulfillment of the pledge will not be treated as more than an insubstantial benefit to the donor and will not subject the donor to a 125% excise tax.

Example 4
After doing some research, Erin's tax professional informs her that the IRS has proposed new guidance which may enable her to advise a distribution from the DAF to the hospital foundation in satisfaction of her pledge. He informs her that she can safely advise the distribution so long as the distribution is done without any reference to the existence of a pledge, she receives no additional benefits from the distribution and she does not try to claim a charitable deduction. Erin decides to move forward and contacts the sponsoring organization to initiate the process. The hospital foundation gladly receives the distribution from the DAF and credits it toward Erin's $5,000 pledge for this year. Erin has been able to accomplish her goal of fulfilling her pledge obligation and holding onto her $5,000 of savings.

It is important to note the Service's rationale with regard to legally-binding pledges. On the one hand, the Service appears to tacitly acknowledge that the contribution from a DAF to satisfy a legally-binding pledge may, in fact, be more than an insubstantial benefit to the donor, when it states, "The Treasury Department and the IRS currently agree with those commenters who suggest that it is difficult for sponsoring organizations to differentiate between a legally enforceable pledge by an individual to a third-party charity and a mere expression of charitable intent." On the other hand, the notice specifically permits such distributions "regardless of whether the charity treats the distribution as satisfying the pledge."

A prudent tax professional should bear in mind that in Notice 2017-73, the Service merely announced its intention to develop proposed regulations. While the Service has announced its position regarding DAF distributions to satisfy legally-binding pledges, there has been no actual change in the law. At best, this notice merely represents a change in posture by the IRS. While a distribution to satisfy a legally-binding pledge may currently carry low risk, a number of circumstances could cause the Service to revert to its former position on the subject. Should the Service fail to propose and enact the announced regulations, legally-binding pledges could once again be off-limits for DAFs. Therefore, ample caution is warranted for practitioners considering this route for their clients.


Donor advised funds can be an excellent way for individuals to effectuate their tax planning goals. Savvy advisors can counsel their clients to use DAFs to continue to make their charitable gifts without sacrificing their deductions. Nevertheless, individuals should exercise caution and understand the rules surrounding permissible DAF distributions in order to avoid the traps that can cause the donor to pay hefty excise taxes. With proper guidance and planning, however, many taxpayers will find DAF gifts to be a tax-efficient and philanthropic solution.

Contact your Community Foundation staff at: (860) 626-1245 to discuss your charitable giving options and goals.