Donor Advised Fund (DAF) Reserve Accounts - Detailed Explanation

A Donor Advised Fund Reserve Account is not a separate legal entity. It is a bookkeeping account within a 501(c)(3) sponsoring organization.

Per IRC 4966(d)(2), a DAF has 3 elements:

1. Separately identified by reference to contributions of a donor or donors
2. Owned and controlled by the sponsoring organization
3. Donor retains advisory privileges only - not legal control

Once you contribute, the gift is irrevocable and unconditional, and the sponsor has exclusive legal control.

What people mean by "Reserve Account" - Two very different uses:

1. Legitimate Sponsor Reserve:
Large commercial sponsors like Fidelity Charitable, Schwab Charitable, National Philanthropic Trust maintain:

• Investment pool reserve: Your DAF balance invested and growing tax-free until you advise grants.
• Operating/fee reserve: A portion held back for administrative fees, minimums.
• Dormant account reserve: Policy that if advisor is inactive, funds eventually must be granted out.

2. Abusive / Promoter Reserve - The IRS Target:
The IRS has warned it is aware of organizations promoted as donor-advised funds that are established to generate questionable deductions and provide impermissible economic benefits.

In these schemes:

• Promoter tells donor: assets transferred may grow tax free and be used later to reimburse donor for expenses, or fund children's education.
• Promoter calls it a "reserve account" or "family reserve" - donor thinks he can borrow back, get loans, pay personal expenses like school for donor's children, payments for donor's own volunteer work.
• Charity sponsor is often complicit.
• This violates the core rule: charity must have legal control and right to disregard donor's advice. If donor retains dominion, there is no completed gift and no deduction.

The IRS 2023 Proposed Regulations under IRC 4966 added an anti-abuse rule specifically to prevent circumvention of restrictions via such reserve structures.

Legal Framework

• Pension Protection Act 2006: First comprehensive DAF law. Created IRC 4966 (taxable distributions), 4967 (prohibited benefits), 4958 excess benefit rules.
• IRC 4966: Taxes sponsoring org for taxable distribution (grant to non-charity, or to donor/advisor, or for non-charitable purpose).
• IRC 4967: Taxes donor/advisor if they receive more than incidental benefit.
• IRC 4958: Excess benefit transaction - broad proposed definition of donor-advisor now includes personal investment advisors managing DAF assets.
• Notice requirement: Sponsoring org must notify IRS in exemption application if it maintains donor-advised accounts and how it intends to operate them.

Case Laws You Must Know

1. Fairbairn v. Fidelity Investments Charitable Gift Fund (N.D. Cal, Case No. 18-cv-04881, Feb 26, 2021)

Facts: Malcolm and Emily Fairbairn donated $100M of stock to Fidelity Charitable DAF in Dec 2017. They claimed Fidelity promised to liquidate gradually to avoid crashing price. Fidelity sold all immediately, price dropped, proceeds lower than expected.

Ruling: Court ruled for Fidelity Charitable. Fairbairns didn't prove broken promises or negligent trading. Participation rate of 15.3% was within acceptable limits for a DAF.

Principle for Reserve Accounts: Court emphasized that once contributed, sponsor has title and control over investment. If sponsor breaks specific promises about liquidation method, donor may have contract claim. But general advisory right is not a property right.

2. Pinkert v. Schwab Charitable Fund, No. 21-16299 (9th Cir. 2022)

Facts: Donor Philip Pinkert sued Schwab Charitable for breach of fiduciary duty, alleging excessive fees from partnering with Schwab & Co for brokerage/custodial services, draining his DAF reserve.

Ruling: District Court dismissed, 9th Circuit affirmed. Donor has no Article III standing to sue DAF sponsor after contribution. No case supports that right to designate investments in pre-selected funds is a contractual or contingent property interest that gives donor standing to challenge fund's choice of investment funds or administrative fees.

Principle: Once money is in DAF reserve, you lose legal standing. Right is advisory only. The sponsor is not required to follow donor's recommendations. This is critical - you cannot sue over how your reserve is invested unless you can prove fraud or specific contract breach.

3. IRS vs. Abusive DAF Promoters - Exemption Denial Cases

• New Dynamics Foundation (Tax Court Memo) and National Foundation, Inc.: IRS denied exemption where orgs operated DAFs where donors retained effective control over reserve accounts, using them as personal tax-sheltered investment accounts. Court upheld denial because charity did not have independent control.
• Fund for Anonymous Gifts cases: IRS testimony notes a case in Court of Federal Claims where exemption denied for DAF-like org that allowed donor reserves to be used for impermissible benefits.

4. Standing Doctrine - FPLG Law Case Insight

Recent ruling held donors have "special relationship" to fund administering their DAF accounts and to gifts bearing their names, giving them standing along with Attorney General to enforce expectations only when DAF sponsor gives them additional rights. Otherwise, Attorney General is proper party.

How to Structure a Compliant Reserve Account

If you are a sponsoring organization or advisor:

1. Agreement language: Must state sponsor has exclusive legal control.
2. No guarantee of reserve return: Never promise funds can be used to reimburse donor.
3. No loans, no tuition: Any distribution that benefits donor = taxable distribution + 4967 penalty.
4. Variance power: Sponsor must have power to redirect reserve.
5. Minimum activity policy: Adopt dormancy policy to avoid accumulation - required under new proposed regs scrutiny.
6. Fee disclosure: All fees from reserve must be reasonable and at FMV or it's excess benefit under 4958.

Red flags IRS looks for:

• Promoter fee based on % of contribution to reserve
• Donor advised to contribute to reserve before year-end for big deduction, with oral promise of personal use later
• Reserve used to pay donor's family members, or invest in donor's business