By: Jamie Lanier, Lane Powell PC
There has been a lot of talk about Washington’s new capital gains tax, levied at a rate of seven percent on Washington residents’ long term capital gains in excess of $250,000. More information on this tax can be found in this article from my colleagues at Lane Powell.
There has been less chatter, and certainly no clear answers, around the unique and somewhat perplexing standard for qualifying for the charitable deduction from Washington capital gains tax. The statue provides[1] that for charitable gifts exceeding $250,000, a taxpayer may deduct up to $100,000 from their Washington capital gains subject to the following: eligible recipient charities must be organizations exempt from tax under Section 501(c)(3) of the Internal Revenue Code of 1986, as amended (the “Code”) that are (i) eligible for a charitable deduction from income tax under Section 170(c) of the Code; and (ii) “principally directed or managed within the state of Washington.”[2]
What does it mean for a charity to be “principally directed or managed within the state of Washington”? The plain language of the statute offers no guidance on this point and the statute has yet to be interpreted by the courts. Does a gift to a Washington branch of a national charity qualify? Does a gift to a Washington-based charity qualify if the charity has activities or provides support outside of Washington? And where do donor advised funds (“DAFs”) fit in? Does the charity administering the DAF need to be principally directed or managed in Washington or must the DAF make distributions to charities directed or managed in Washington?
The Washington Department of Revenue has issued proposed draft rules intended to provide clarity on different aspects of the Washington capital gains tax statute, including the following commentary on the charitable deduction:
“Principally directed or managed within the state of Washington means that an organization’s high-level officers primarily direct, control, and coordinate the organization’s activities in Washington. An office location in Washington alone does not establish that the organization is principally directed or managed in Washington. For example, a Washington location is insufficient for this purpose if it is not used to direct, control, and coordinate the organization’s activities.[3]
Thus, the proposed draft rules clarify that a contribution to a charitable entity qualifies for the deduction if the entity has a physical office in Washington and the officers primarily direct, control, and coordinate the organization’s activities from the Washington office. The proposed rules do not, however, define what constitutes “direction” vs “management.”
The proposed draft rules further provide:
Generally, a donor-advised fund is a separately identified account that is maintained and operated by a nonprofit organization, and each account is composed of donations that are made by individual donors. Although the nonprofit organization has legal control over it, individual donors maintain advisory privileges with respect to the distribution of funds and management of the account’s assets. If you donate to a donor-advised fund or a similar intermediary charitable vehicle, that fund or intermediary must qualify as a qualified organization under RCW 82.87.080. The organization to which you make the donation, and not the organization where the donation ends up, determines whether you donated to a qualified organization.[4]
This commentary is helpful in clarifying the relevant charity in a DAF situation. The DOR looks at the DAF itself and not the charitable recipients that receive funds from the DAF. That should be the end of the story: a contribution to a DAF should qualify for the deduction so long as the contribution to the sponsoring charitable organization would qualify. After all, the sponsoring organization should be the one “principally directing or managing the DAF,” with ultimate decision making authority over directing distributions from the DAF.
But, the definition of “direction” vs. “management” remains unclear. So, for the sake of argument, could the DOR attempt to characterize the donor of a DAF as “principally directing or managing” a DAF, in which case you would have to analyze the location and activities of the DAF donor too? The answer to this should be a resounding “NO”! A donor has zero management or direction over a DAF – it is crucial that the donor give up dominion and control over the gift in order to have a completed gift and qualify for the deduction. Often the donor serves as the DAF advisor, offering non-binding suggestions to the DAF administrator regarding distributions. Could a DAF advisor be characterized as principally directing or managing the DAF? The concept of an “advisor” is antithetical to a director or manager. An advisor does just that – they advise – while the sponsoring charity is entirely responsible for directing and managing the DAF. Even if an advisory role could constitute “directing,” it does not rise to the level of “principally directing” since ultimate authority rests with the DAF administrator.
Let’s use the Seattle Foundation as an example (full disclosure, I am a member of the Seattle Foundation’s Professional Advisors Council):
- Seattle Foundation is a public charity exempt from income tax under Section 501(c)(3) of the Internal Revenue Code.
- Seattle Foundation’s physical office is located in Seattle, Washington.
- Seattle Foundation’s high level officers are located in Washington.
- Seattle Foundation administers donor advised funds.
Under the proposed draft rules, it is clear that a direct contribution to Seattle Foundation should qualify for the charitable deduction because it is a 501(c)(3) organization principally directed or managed within Washington. It should also follow that a contribution to a DAF administered by the Seattle Foundation should qualify.
As discussed above, out of an abundance of caution, because of the somewhat opaque discussion of DAFs in the proposed draft rules, it may be prudent for the DAF donor and advisor to also be located in Washington to avoid any argument by the DOR that the DAF was principally directed or managed outside of Washington.
And, to tie it all up, if the DAF ultimately makes a distribution to a national charity or a Washington-based charity with activities or support outside of Washington, that should not affect the analysis because the proposed draft rules make clear that the DOR looks at the DAF itself and not the charitable recipients that receive distributions from the DAF.
Jamie Lanier is a shareholder with Lane Powell PC. She is a member of the Private Client Services Team and co-chair of the Nonprofit Team. Reach her at [email protected].
Disclosures/Disclaimers: This article is the opinion of the author and is not intended to be legal advice or specific individual advice. Consult your own tax professional before making any decision regarding the Washington capital gains tax and charitable contributions. The author is a member of Seattle Foundation’s Professional Advisors Council.
[1] RCW 82.87.080
[2] RCW 82.87.080(4)(emphasis added)
[3] WAC 458-20-301(2)(l)
[4] WAC 458-20-301(4)(b)(ii)