The professor and specialist in nonprofit law and philanthropy talks to Michael E. Hartmann about the history and purpose of the public-support test, the “Grand Bargain” of the 1969 Tax Reform Act and the “new bargain” of the 2006 Pension Protection Act, and potential explanations for the use of donor-advised funds to avoid the test and its ramifications.
Benjamin M. Leff is a professor at American University’s Washington College of Law, which he joined in 2009 and before which he was a visiting assistant professor at Harvard Law School. Leff’s scholarly interests include U.S. federal tax law and how it and its implementing regulations apply to philanthropic and other nonprofit organizations.
He practiced law at Vinson & Elkins in Austin, Tex., from 2001 to 2007. He joined the firm after clerking for federal judge Douglas P. Woodlock in Boston. His Yale Law School degree followed completion of the Ph.D. coursework at the University of Chicago Divinity School.
In Leff’s recent “Getting Donor-Advised Fund Regulation Right: Closing the Public-Support Test Loophole,” he examines donor-advised funds (DAFs) and the loophole that DAF law and regulations create that allows donor avoidance of the public-support test to which they would otherwise be subject. He recommends a “bright-line” rule that would close the loophole, consistent with a 2017 Treasury Department notice, and which he maintains would actually further the at-least stated charitable purpose of DAFs.
The engaging Leff was kind enough to join me for a recorded conversation about these and related issues last week. The just more than 20-minute video below is the first part of our discussion; the second is here. During the first part, we talk about the history and purpose of the public-support test, the “Grand Bargain” of 1969 Tax Reform Act and the “new bargain” of the 2006 Pension Protection Act (PPA), and potential explanations for the use of DAFs to avoid the test and its ramifications.
“The public-support test is the fundamental way that Congress enacted into law a way to distinguish between private foundations and public charities,” Leff tells me.
Simplifying a little bit, basically, the public-support test says that if you have multiple people, unrelated donors, then you’re a public charity, and if you don’t have multiple unrelated donors, then you’re a private foundation. … Fundamentally, it’s the way that Congress divided the world of charities into two camps, and they did that specifically to apply a more-strict regulatory regime to private foundations. It’s built on this theory that having multiple unrelated donors is itself a check on the organizations.
Beginning in the 1950s, “there were pieces of legislation that distinguished between public charities and private foundations, or created a new class of charities without using that vocabulary that effectively became private foundations,” according to Leff. But the public-support test really came into being with the 1969 Tax Reform Act, which still essentially legally structures the entire nonprofit sector.
Leading up to the ’69 Act, “Congress held a whole bunch of hearings that were very, very critical of some of the things that we’re going on in private foundations,” he says. With the Act, “they crafted what I think you have referenced [and] that I have referenced, what has been called this ‘Grand Bargain,’ this set of tighter restrictions on private foundations” in return for their tax-advantaged status. “The public-support test,” he continues, “is a key component of how you know who falls into that category of private foundations and therefore [is] subject to this tighter set of regulations.”
DAFs are often described as a kind of “charitable savings account.” Donations to a DAF provider or sponsor are tax-deductible, like donations to any other tax-exempt public charity. DAF providers track individual donor accounts and invest the donors’ contributions for them in large, tax-free investment pools until donors specify where they wish to make grants. Funds can be left to grow in DAFs indefinitely, though donors get the tax deduction up-front.
“The way that donor-advised funds are structured, they have some of the benefits of a private foundation,” Leff explains. DAFs can do what private foundations do “on a kind of smaller scale, and they themselves don’t count as private foundations because of the public-support test.” A DAF “sponsor has lots and lots of” DAF accounts, “so it’s getting lots and lots of contributions from unrelated people, so it’s a public charity.”
As public charities, DAF sponsors “avoid all of the rules on private foundations,” he says. But in 2006, “Congress—after not as robust criticism as way back in 1969—” had some “alarm that DAFs were being used to avoid the private-foundation restrictions in ways that seemed abusive.” So the ’06 Pension Protection Act created, “for the first time, a special regulatory regime for donor-advised funds.”
The PPA is a “new bargain,” Leff writes in his “Getting Donor-Advised Fund Regulation Right” paper. The PPA “didn’t just say DAFs are private foundations, or it didn’t just say you should apply the public-support test on a fund-by-fund basis or something like that. In some ways, that would have been really simple,” Leff further explains. “Instead, it maintained the public-charity status of DAF sponsors and then it enacted a series of provisions that in some cases applied the same rules that apply to private foundations to the donor-advised fund” and “[i]n other cases, it actually created an even more-strict regulatory regime for” DAFs.
Leff then describes the resulting public-support test loophole, deploying a hypothetical. “If I create a charity, like the Ben Leff Fund, and if I were to donate money directly to it—I’m the only donor, I give it a million dollars—it would be a private foundation,” according to Leff. “But if instead, I just donate the money to the donor-advised fund and then I say to the donor-advised fund, ‘Hey, will you distribute that money out to the Ben Leff Fund?’—and it can take literally two minutes—I could donate it” to the DAF
and in the same breath, say, ‘Hey, distribute 100 percent of the money I just gave to you out to the Ben Leff Fund.’ The Ben Leff Fund has a million dollars. It came right from me. It didn’t come from anyone else. Under current law, that would be a public charity, not a private foundation. It’s like a bounce pass, or a conduit, or a loophole, that structure—the fact that under current law, you can create a charity which really in principle and under prior law, really should be a private foundation.
In fact, a private foundation itself could even make a grant to a nonprofit, then create a DAF account of its own and donate money to the DAF provider to support that same nonprofit through the account.
“When Congress passed this Act in 2006, they just didn’t think of this” loophole, “so they didn’t close it,” Leff notes.
“It’s hard for me to convey how sincerely I mean this: I don’t know how much this strategy is being used for” avoiding the terms of the ’69 Grand Bargain, he says, though his paper allows for explanations of DAFs’ popularity that are “plausibly more sinister.”
“The ultimate abusive purpose would really primarily be to use this entity to engage in some kind of self-dealing,” says Leff, entertaining some such explanations.
There are other things that you could use this entity for. For example, if you want to use your entity for political ends, private foundations are much more restricted than public charities in what kinds of political spending they can do and that’s especially true when you add a 501(c)(4) organization into the mix. So if I bounce pass into a public charity and then that public charity makes grants to a 501(c)(4) organization, it would be much more restricted in how it did that if it was a private foundation making those grants than if it’s this public charity. So there’s lots of opportunities for abuse ….
Gently coaxed to be more skeptical, if not outright cynical, about human nature and just acknowledge that such abuses likely occur, the onetime divinity-school student politely demurs. “I think the common sense of it is good enough without having to impute motives to any particular philanthropist,” he says.
I don’t have great evidence of a sinister user, and it’s not really that important when you have such a basic flaw in the regulatory regime that creates the opportunity for abuse. It would be great if I had good evidence of how widely it’s being used and how much abuse is being caused, but it’s not necessary to understand that we have a regulatory flaw.
In the conversation’s second part, Leff discusses whether private foundations got a better or worse bargain in the ’69 Tax Reform Act than DAFs got in the ’06 Pension Protection Act, the benefits of “bright-line” rules in the context of the public-support test loophole specifically, but also others in philanthropy and nonprofitdom, and the “low-hanging fruit” of closing DAFs’ public-support test loophole compared to other contemplated reforms.
