If you would like to make a substantial tax-deductible charitable donation this year, but have the ability to spread the actual distribution of funds to specific charities over a number of years, a donor-advised fund (DAF) may fill that need. There are any number of reasons individuals choose DAFs, including making a substantial charitable donation in an exceptionally high-income year, to overcome the standard deduction, or as part of their estate plan. Here are some details about DAFs that will help you decide if you can gain any benefit from a DAF.
What is a DAF? – A DAF is a separate fund (account) set up within a public charity (sponsoring organization) to which a donor contributes cash or non-liquid assets. The donor then advises the sponsoring organization on how to invest and ultimately distribute the funds from the account as charitable gifts over the course of many years.
Sponsoring Organization – Tax law allows the sponsoring organization to be independent, community-based, religiously affiliated, or connected with a financial institution. There are typically minimum contributions ranging from $5,000 to $25,000. The sponsoring organization manages the administration of the fund and handles the tax reporting, usually for an annual fee of 1%. In exchange for managing the fund, the sponsoring organization customarily charges an administrative fee based on a percentage of the deposit, which is typically around 1% for smaller deposits.
Tax Benefits of DAF – You get to take a tax deduction for your entire donation in the year you contribute the funds or assets to the DAF. You are not required to wait until distributions are made to your designated recipients. In addition, the funds that are not distributed are invested and grow tax-free.
Here are situations where a DAF can be beneficial.
- Use the bunching strategy – Where your itemized deductions, which include donations to qualified charities, are less than the standard deduction, it will not make any difference for tax purposes whether you made a charitable donation or not. With the recent restructuring of taxes, the standard deductions were almost doubled, which made it more difficult for the average taxpayer to benefit from charitable donations.
In such situations the bunching strategy works well. When using this strategy, you bunch your deductible charitable contributions for more than one year into a single year, which then gives you enough deductions to itemize for that year and then you take the standard deduction in the subsequent year(s).
A DAF is a good vehicle to use for bunching since you make multiple years of charitable contributions to the DAF and then request that the sponsoring organization to dole out the funds to your favorite charities over a period of years.
- Unusually high income – Where you have had an unusually high income year, maybe because of selling a business or a real estate property, making a killing in the stock market, earning a big bonus, winning the lottery, etc., you may want to contribute a large portion of your good fortune to charity by making a substantial tax deductible contribution to a DAF and direct the DAF to make contributions to your favorite charities for years to come while benefiting from itemizing your deductions in the year when you have an extraordinarily higher marginal tax rate.
- Avoid capital gains tax on appreciated assets– A huge benefit to DAFs is that you can donate in-kind, appreciated property such as securities, and avoid paying for the appreciation in value that would have resulted from selling those assets. The donor gets a tax deduction for the fair market value of the donation and avoids capital gains tax.
- Estate Planning – You may simply wish to set up a charitable fund to which you can contribute a portion of your estate and have a future say-so on where the funds will go without the hassle of the legal, administrative and tax filing requirements which are handled by the DAF, allowing you to focus solely on the charitable nature of the fund. This is especially time-saving for the donor when transferring non-cash assets to several organizations.
Substantiation Requirements – To claim a deduction to a DAF as a charitable contribution you must obtain a contemporaneous written acknowledgment from the sponsoring organization of the DAF stating that the organization has exclusive legal control over the assets contributed, as well as the usual general substantiation requirements for charitable contributions.
Another advantage of DAFs is that you can make anonymous contributions. If you are interested in learning more about DAFs and how a DAF might fit into your particular financial and tax situation, please give this office a call.
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