Navigating Regulations: Private Foundation vs. Donor-Advised Funds
Published on by Portia Kohls in Not-for-Profit
As charitable giving strategies evolve, two popular vehicles—private foundations and donor-advised funds (DAFs)—continue to shape the non-profit landscape. While both offer tax-advantaged paths for supporting charitable objectives, they’re governed by different regulations that significantly impact how funds are administered, disclosed, and distributed.
Today we’re highlighting key regulatory distinctions, focusing on guidance issued by the Internal Revenue Service (IRS) and the Pension Protection Act of 2006. Whether you’re advising donors, managing a foundation, or overseeing non-profit compliance, understanding these rules is critical for informed decision-making.
Private foundations: more control, more oversight
Excise taxes (IRC §§ 4940–4945)
Private foundations are subject to a 1.39% excise tax on net investment income under IRC § 4940. This is a nominal tax on the earned investment income of the organization, but notable as most tax-exempt organizations do not pay any tax on their income.
Additional excise taxes can be assessed for specific transactions involving self-dealing, failure to distribute income, excess business holdings, jeopardizing investments, and taxable expenditures.
Minimum distribution requirement
Private foundations must distribute at least 5% of their net investment assets each year for charitable purposes (IRC § 4942).
Restrictions on self-dealing
IRC § 4941 prohibits most transactions between a private foundation and its disqualified persons, including the donor, family members, and substantial contributors. Therefore, when establishing a private foundation, it’s essential to clearly define expectations for how the funds may be used.
Disclosure requirements
Private foundations must file Form 990-PF, which publicly discloses financials, compensation, and a full list of grants and grantees each year.
Donor-advised funds: simpler structure, more ambiguity, less control
Donor-advised funds (DAFs) are managed by public charities and allow donors to make permanent contributions, receive an immediate tax deduction, and recommend grants over time. While they offer flexibility and confidentiality, their regulation has drawn increased scrutiny.
Per the IRS definition (IRC § 4966), a DAF is a separately identified fund maintained by a sponsoring organization where donors retain advisory privileges over distributions. It’s critical to understand that a donation made to a DAF that the funds are no longer funds owned by the donor. These funds become under the control and ownership of the sponsoring public charity.
Key regulatory considerations for donor-advised funds:
Prohibited benefits (IRC § 4967):
Donors, advisors, or related persons may not receive any more than a minimal benefit from a DAF distribution. Violations can trigger excise taxes on both the donor and the sponsoring organization.
Eligible grantees
DAFs may only make grants to organizations recognized as public charities. Grants that result in personal benefit, fulfill a personal pledge, or support individuals aren’t allowed.
Excise tax on improper distributions (IRC § 4966)
If a DAF makes a distribution to a non-qualified organization, a 20% excise tax may apply to the sponsoring charity, with an additional 5% penalty possible for responsible individuals.
Disclosure and reporting
DAFs are reported on Form 990, but individual fund details aren’t publicly disclosed, leading to calls for increased transparency in Congress and from watchdog groups.
Regulatory updates and ongoing developments
The Pension Protection Act of 2006 was the first major piece of legislation to formally define and regulate DAFs. In Notice 2006-109, the IRS provided temporary guidance to help organizations comply with donor-advised fund rules. More recently, in 2023, it released proposed regulations to clarify key definitions and strengthen oversight of excise taxes and donor advisory roles.
These proposals aim to:
- Refine the definition of “donor,” “donor advisor,” and “distribution”
- Crack down on indirect self-dealing and grant arrangements that undermine benefit restrictions
- Introduce further penalties for abuse of advisory privileges
While the rules aren’t final yet, non-profit professionals should keep a close eye on updates and consider how proposed changes may affect fund operations and donor behavior.
| Private Foundation | Donor-Advised Fund (DAF) | |
|---|---|---|
| Setup & Cost | High (legal, administrative) | Low (via sponsoring organization) |
| Control | Full control over investment & grants | Donor can recommend, but sponsor retains final control |
| Reporting | Public Form 990-PF | General reporting via Form 990 |
| Minimum Distribution | 5% annually | No minimum (currently) |
| Tax Deduction Limit | 30% (cash), 20% (securities) | 60% (cash), 30% (securities) |
Final thoughts
Understanding the regulatory landscape surrounding private foundations and donor-advised funds is essential for advisors, non-profits, and donors alike. While DAFs offer convenience and privacy, private foundations provide full control and legacy planning—at the cost of higher scrutiny.
With increased attention from Congress and the IRS, staying current on legal requirements and best practices will help organizations mitigate risk and operate with confidence. If you have questions about which solution is right for your situation, contact us today to set up a free consultation with one of our non-profit pros. As always, we’re here to help.
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Don’t miss our Non-Profit Toolkit, packed with resources to help you make the most of your organization’s mission. You might also enjoy our Thrive Non-Profit Success Stories video series with stories to inspire you, or this educational video on what Form 990 can do for your non-profit (it’s so much more than just an informational return).
