Use a Donor Advised Fund to Maximize Charitable Impact
Americans gave almost $500 billion to charity in 2022. Most people give to charity because they value helping others, not for the tax deduction. However, tax-efficient philanthropy keeps more money in donors' pockets and increases the amount they can gift in the present and future.
A Donor Advised Fund is one of the most effective tools for maximizing your charitable impact. This blog will teach you how to use them effectively.
What is a Donor Advised Fund (DAF)?
A DAF is an investment account strictly for charitable giving. They are available through sponsoring organizations like financial institutions (Fidelity, Schwab, etc.) and non-profits.
When you contribute to a DAF, you receive an upfront tax deduction for the gift. The assets you donate can then be reinvested in a blend of investments that grow tax-free.
You can make additional gifts to the DAF in the future and recommend grants to your favorite charities in whatever amount and frequency works best for you. The details are outlined below:
Donate to the DAF
You can contribute an array of assets to DAFs. They generally accept:
- Cash
- Pre-IPO shares
- Cryptocurrencies
- Publicly traded securities
- Private equity and hedge fund interests
- Certain privately held assets like S-corp and C-corp shares
Check with the sponsoring organization for the exact list of accepted assets.
It’s important to remember that once you transfer assets, they are no longer in your ownership. However, you’ll still be able to choose how the DAF is invested and which charities to recommend grants to.
When you donate cash or long-term securities, you’ll receive an immediate itemized deduction based on the asset's FMV. Non-cash gifts held for less than a year are eligible for a deduction equal to the asset's basis.
The total amount you’re allowed to deduct in a year is limited to:
- 60% of AGI* for cash gifts
- 30% of AGI for non-cash gifts
*Adjusted Gross Income
Any amount over the limit can be carried forward for five years. This makes DAF gifts most beneficial in years with high income.
Invest Your Donation
After you transfer assets to the DAF, the sponsoring organization will sell the assets, then reinvest the proceeds in a blended portfolio of your choosing. DAFs with higher balances may be allowed to invest in more sophisticated portfolios.
Since the sponsoring organization is a 501(c)(3) charity, neither you nor the charity will be responsible for capital gains tax on the sale. So, not only do you receive a tax deduction for the value of the gift, but you escape paying capital gains tax on the embedded gain.
Additionally, the reinvested proceeds compound tax-free.
Recommend Grants to Your Favorite Charities
When the time comes to donate to the charities of your choosing, you’ll follow this process:
- You recommend a grant to the sponsoring organization
- The sponsoring organization confirms the grant is legitimate
- Once confirmed, the sponsoring organization will send a check to the charity
Generally, the sponsoring organization will need to confirm the charity you identified is a public charity and that you won’t receive a benefit for the donation.
So long as your recommended grants meet the criteria and the DAF balance is sufficient to fund the gift, you can recommend grants in any frequency or size you desire.
When does a DAF Make Sense?
Savvy donors use DAFs for flexibility and tax-efficient philanthropy. Donors can gift cash to a DAF, but they’re better utilized for advanced planning techniques discussed below.
Avoid Capital Gains Tax
Remember how neither you nor the sponsoring organization is responsible for paying tax on capital gains triggered inside the DAF?
This creates unique opportunities to gift:
- Low-basis, high-value assets
- Concentrated portfolio positions
- Private/Pre-IPO stock with minimal basis
Making the DAF an ideal solution for:
- Business owners preparing to sell their company
- Sales professionals with an abnormally high-income year
- Corporate executives with low basis, concentrated holdings of company stock
Remember that gifts of private stock will require a business appraisal and should be planned for prior to the company’s sale.
Reduce Your Taxable Estate
Since assets transferred to a DAF are no longer in your ownership, DAFs are a great tool for philanthropic families to support their preferred causes and organizations instead of paying estate taxes at a rate of 40%.
Speaking of estate planning, donors can name their children, other family members, friends, etc., as successor donors of their DAF so they can carry on the original donor’s charitable legacy. If you don’t have a successor donor, you can name a charitable beneficiary to receive the balance of the DAF when you pass.
DAF Best Practices
1) Make gifts in years with high income
2) Gift low basis, highly appreciated assets
3) Bunch years of smaller gifts into one large gift
4) Use DAF gifts to remove portfolio concentration without paying taxes
Conclusion
DAFs are a powerful tool for fulfilling charitable intent and reducing taxes. Not only does tax-efficient gifting leave more money for you and your family, but your charitable gifting goes further.
Disclosures
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