Words by Helen Flannery and Chuck Collins
Photo by Markus Winkler on Unsplash

DAFs channel huge amounts of cash to ‘culture war’ groups – anonymously. Why do people get tax breaks for using them?

US law lets wealthy people get substantial tax deductions if they donate to charitable organisations.

If you’re really, really rich, your income tax can run into tens or even hundreds of millions of dollars. Charitable giving is recognised as a public good, and so the US government rewards donors by slashing their tax bills – sometimes, in the right circumstances, almost completely. It can even work out more beneficial in the long run to donate assets to charity than it can to sell them.

But giving to charity on this scale, and properly reporting those donations to the tax authorities, can be complicated. Enter donor-advised funds, or DAFs, a type of private account through which Americans can secure those tax breaks quickly – without actually having to give directly to good causes.

Setting up a DAF lets a donor claim the benefits of charitable giving immediately, while allowing them to take their time recommending where the money should ultimately go. They were originally intended to make charitable giving easier and thereby encourage more people to do it.

Here’s the problem, though: the money put into a DAF never actually has to move to organisations working directly for the public good.

And when DAFs do make distributions to qualified charities, they are able to do so anonymously – meaning donors can use them to funnel untraceable gifts to hate and anti-government groups, as long as those groups qualify as US charities.

Last year, for instance, openDemocracy revealed that DAFs had been used to channel $272m anonymously to 36 ‘culture war’ groups involved in campaigns against women’s and LGBTIQ rights in the United States and abroad between 2017 and 2020.

Here’s what you need to know.

What are donor-advised funds?

Donor-advised funds, or DAFs, are a creation of the US tax code and are often described as charitable checking accounts. But instead of being administered by a bank, a DAF account is administered by a charitable organisation, which is called a sponsor. (The fact that DAF operators are charitable is what allows donors to benefit from tax breaks.)

Donors can contribute to a DAF account and take an immediate tax deduction for that gift, since they are technically giving it to a charity. The sponsor of that account then legally controls the money, but gives the donor broad advisory privileges to recommend grants out of the DAF to whichever other eligible charities they want, on whatever schedule they want.

Almost any type of charity can be a DAF sponsor. Some are working charities, which are organisations that work directly on issues affecting the public, like Greenpeace and the Red Cross. Some are community foundations, which are organisations that give grants to local charities in a specific geographic region, like the San Francisco Foundation or the New York Community Trust. And some – including the very largest charities in the US – are charitable organisations established by Wall Street wealth management firms, such as Fidelity Investments and Charles Schwab.

Unfortunately, there is a fundamental design flaw: there is no minimum payout requirement for DAFs whatsoever, meaning funds in DAFs don’t ever actually have to move out at all. While many donors move funds within a couple of years, many others park funds in DAFs indefinitely.

Are DAFs common?

DAFs are growing explosively. The assets held in US DAFs have grown by 411% over the past 10 years, from $45bn in 2012 to $229bn in 2022. And DAFs have been carving out an increasingly larger chunk of the charitable market for themselves. They now take in more than a quarter of all individual giving in the US: seven of the top ten recipients of charitable donations in the country – including the four largest – are now DAF sponsors.

But most DAF donations come from a tiny sliver of the wealthiest people in the US, since only they have high enough incomes to qualify for the charitable tax deductions that DAFs bring. The best estimates are that the typical DAF donor earns more than $1m a year.

Why should we care about DAFs?

For one thing, donations to DAFs slow the flow of funds to actual working charities. DAFs offer enormous tax incentives for donors to put money into them, and virtually no incentive to move the money out. But US taxpayers subsidise them, because by being tax-exempt they reduce the amount of tax revenue money the government has available for public services. That means either higher taxes for everyone else, a larger and more expensive role for the private sector in their lives, or simply worse (or missing) services.

In exchange, those contributions are supposed to be used to support charities working for the public benefit. When donations just build up in DAF accounts, taxpayers are getting no return on their subsidy at all.

How are DAFs different from foundations?

DAFs and private foundations are both intermediary giving vehicles. People get tax deductions in the year of their donation for giving the money away, and then the money sits in the vehicle – sometimes for years – until it’s granted back out again to working charities.

But DAFs, for historical reasons, have several advantages for donors over foundations. Foundations are expensive, often requiring an initial donation in the hundreds of thousands of dollars, while most DAF accounts require just $5,000 or $10,000. Foundations have to disclose their major contributors and where their grants go, while DAFs don’t have to reveal their contributors. DAF sponsors only have to report on their grant-giving at an overall level, not for individual accounts. And, perhaps most importantly, foundations have to distribute at least 5% of their assets to charity every year, whereas DAFs don’t have any distribution requirement at all.

An interesting twist to this whole picture, however, is that foundations can give grants to DAFs, and can use those grants to meet their entire 5% payout requirement. In 2021, for example, private foundations gave at least $2.6bn to donor-advised funds – and for 147 of these foundations, those grants to DAFs were the only charitable payouts they made that year.

Are DAFs a way of giving, or of making money, or both?

Donor-advised funds were originally meant to be instruments for social good, but they are becoming warehouses of charitable funds. Many DAF sponsors are now contributing to the financialisation of philanthropy by deliberately emphasising the tax benefits and control they provide to their donors, and de-emphasising the end product – the actual grantmaking. And because DAF giving is completely anonymous, charities don’t know how to approach or communicate with DAF donors, contributing to their fundraising challenges.

Would policy reform help?

Every year, more charitable revenue is diverted into donor-advised funds while charities on the ground struggle harder for funds. And in the absence of adequate regulation and transparency, DAFs are ripe for abuse by donors and for-profit companies alike.

Well-designed policy would increase the flow of charitable dollars, ensure greater accountability, and curb the abuse of donor-advised funds. Most importantly, US legislators should establish a distribution requirement for donor-advised funds. For example, DAFs could be required to pay out all donations within a set number of years, including any income earned during that time.

Other reforms that could help include preventing private foundations from counting grants to DAFs towards their distribution requirement; requiring commercial sponsors to have separate management from for-profit sister corporations; and prohibiting endowed DAF accounts, which are low-payout accounts that are meant to last essentially forever.

There is broad, bipartisan public support in the US for changes like these. But so far, attempts to reform the system to make DAFs more accountable have been defeated by stiff opposition from the DAF industry.

This article was originally published on Open Democracy, where you can read the original article.