Donor Advised Funds – A Tax Efficient Way of Giving
Filed under:Tax Strategies
The new complexities and depth of changes in the new tax law have created the need for clients to implement different planning strategies to achieve their goals with greater tax efficiency—and we have been working with many of them to do just that.
Charitable giving has been one of the many major points of discussion around this topic. Given that the federal standard deduction has doubled, many clients have asked if they should still keep track of their donations. The answer is, almost always, yes. If not for federal tax purposes, then in many cases donations still make a difference on the state income tax return (since state itemized deductions have not increased in the way the federal deductions have). However, there are various tools and techniques for charitable giving available to help improve the federal tax deduction as well.
One common strategy we have used is to “bunch” charitable donations by donating more in one tax year to receive a more significant deduction and then donating less in future years to compensate. For example, a donor could bunch two to three years of giving into one tax year, instead of spreading the donations over multiple tax years; the donor’s total giving amount stays the same, but bunching multiple years of giving into one tax year achieves an itemized deduction greater than the standard deduction (thereby recovering the charitable tax deduction) and reduces taxable income.
There are many ways to donate to charity using a bunching strategy, including making a one-time larger direct contribution to a charity (the simplest and most straight forward method), deferred giving through charitable trusts, and giving through a private foundation, among others.
Donor-Advised Funds (DAFs) are an additional method of giving that come with many of the benefits of giving to a private foundation, but at less expense and often with greater tax benefits.
DAFs are often described as “charitable checking accounts”. Donors make irrevocable contributions to a DAF sponsor and then send out donations from their DAF account to the qualified charitable organization of their choice.
- At the time of contribution, the donor gives up complete, legal control of the donated assets (cash, securities, etc.). Note that additional tax benefits are available when contributing highly appreciated assets.
- In return for the contribution, the donor receives an immediate tax deduction for the donated assets.
- The sponsor has legal control of the donated assets; however, the donor advises the sponsoring organization as to the dollar amount, timing, and qualified recipient of charitable grants made from the donor’s account.
- Under current law, there is no legal requirement that any charitable grant ever be made from a donor’s account. Until a charitable grant is made, the assets in each account are invested and grow tax-fee.
A donor can make a donation to a DAF during a year and take an income tax deduction in the year of contribution, but delay making an actual charitable grant until later years and/or over multiple years. In addition, it leaves flexibility for donors in deciding who they would like to receive the charitable grants (giving is not limited to a single recipient or the same recipients for all grants; recipients only need to be a qualified charitable organization).
The choice of how, when, and to whom to give charitable gifts can be complex. Regardless of how donors choose to give, it is advisable that they talk with their financial advisors to identify the strategies that best meet their goals.