Tax Planning and Donor-Advised Funds (DAF) for Charitable Giving
According to the National Philanthropic Trust, the fastest-growing charitable giving vehicle in the United States is the donor-advised fund, accounting for 10.2% of all individual charitable giving in 2017.
DAF: What Is It Exactly? A DAF is a charitable giving account administered by a public charity or a charitable gift trust that is managed by a financial institution. According to a 2016 Washington Post article, the Fidelity Charitable Gift Fund was the largest recipient of charitable funds in the US, surpassing the funds received by the United Way!
Tax Planning With a Donor-Advised Fund (DAF)
In the future, the percentage of individual charitable giving will most likely increase above the 2017 amount of 10.2%. Why? Because the 2018 tax law changes diminished the tax benefit of charitable contributions for many taxpayers by significantly increasing the standard deduction (for 2019 $12,200 for singles, $24,400 for married filing joint) and limiting state and local income tax (SALT) paid to a maximum of $10,000. Due to these changes, most taxpayers will no longer itemize their deductions on Schedule A, the same form where charitable contributions are reported. So yes, charitable contributions are still deductible, but most people will not claim them because the standard deduction will be greater than the sum of all itemized deductions. For more information on the new tax law, I geeked out on the new tax law at the start of 2018. The blog post is HERE.
In order to still deduct charitable contributions, even if you don’t itemize your deductions, you can use a DAF to bunch a few years’ worth of contributions into one year to push the total of your itemized deductions above the standard deduction. You can then distribute the funds yearly, in the amount you desire, to the charitable organizations you want to support. Obviously, you have to have the cash to front-end load your charitable contributions. But by making the larger contribution to the DAF, you can turn a non-deductible contribution into a deductible contribution.
You can invest your funds within a DAF. The most popular are managed by Fidelity, Vanguard, and Schwab. They do have minimum contribution amounts and fees that you have to consider. Let’s dive into the pros and cons of donor-advised funds (DAF).
What is a donor-advised fund, and is it right for you? (Take the quiz to find out!)
DAF: How Does It Work?
- A donor creates an account and funds it with donations of cash, stocks, non-publicly traded assets, and more.
- The donor can then make decisions on how the assets are invested and make recommendations on which charities to support. The donor can schedule recurring grant recommendations to any IRS-qualified public charity or make one-time grant recommendations.
- The donor receives a current year tax deduction—up to IRS limits based on the donor’s adjusted gross income for the year. This is true even though funds may not be directed to charities until a later date.
- Charitable gift trusts may charge administrative fees plus investment fees on the underlying assets. For example, the Fidelity Charitable Gift Fund currently charges an administrative fee: .60% of assets or $100 annually, whichever is greater.
DAF: What Are the Advantages?
- Administration of assets and disbursement of funds is handled by the trust.
- Gifting can be done anonymously to reduce future solicitations from charities.
- Funds grow tax-free in the DAF.
- Since funds are no longer assets of the donor, the donor avoids income taxes on earnings.
- This elimination of income taxes may result in more funds being available for charitable giving.
- The DAF can provide significant tax savings. This is especially true in light of changes made to itemized deductions by The Tax Cuts and Jobs Act of 2017 (TCJA). The TCJA increased the standard deduction and placed limitations on some itemized deductions while eliminating others entirely. While the deduction for charitable contributions was retained, the overall result of these changes is that significantly fewer taxpayers will be able to itemize deductions going forward.
- A DAF donor can make large donation in certain years in order to exceed the standard deduction threshold and increase his/her tax deductions.
- The donor can also choose to make donations in years in which he/she is subject to a higher tax rate in order to reap the most benefit from the deduction.
- The DAF allows the donor to realize the income tax benefit without making an immediate decision about which charity will ultimately get the funds.
- The donor can further leverage tax benefits by contributing highly appreciated assets to the DAF. The donor gets a deduction equal to the fair market value of the assets and does not realize capital gain on the appreciation.
- Assets contributed are no longer part of the donor’s estate, so they aren’t subject to estate taxes. Since a donor can name a successor who will have account privileges, he/she can pass down philanthropic control to future generations.
DAF: What Are the Disadvantages?
- Donations made to the DAF are irrevocable.
- Though the donor can make decisions, there is usually a menu of investment options to choose from, and the managing trust has the ultimate authority to invest funds.
- Similarly, the managing trust has the ultimate authority to approve or deny grant recommendations—though typically grants would only be denied if the charity did not meet IRS guidelines or the amount requested was less than the grant minimum established for the account.
- Some critics argue that separating the current tax deduction from the actual grant to charity means that funds could languish in a DAF for years without serving a charitable cause.
Is a DAF Right for You?
If you want to make cash donations that are typically smaller, and you know which charities you would like to contribute to, a DAF is probably not right for you.
If any of the following situations apply, a DAF would work for you:
- You have a desire to contribute an amount equal to or larger than the DAF minimum (as low as $5k at some fiduciaries) but prefer to make the payout at a later date—maybe because you need time to choose the recipients or want to grow the balance.
- You already make recurring charitable contributions and would like to pass the administration along to someone else.
- You would like to take advantage of the tax-efficiencies of a DAF by contributing a large sum in one or more years or by making contributions of appreciated assets that some charities are not equipped to accept.
- You would like to start a legacy of charitable giving that future generations can participate in while at the same time reducing your taxable estate.
If we can help you further, with a question regarding using DAFs for charitable giving or anything else, PLEASE don’t hesitate to contact us. We eat, sleep and breath this stuff, and would love to help you. Honestly, don’t hesitate. We won’t bite 🙂