Thanks to the Tax Cuts and Jobs Act enacted in 2017, use of donor-advised funds (DAFs) is soaring. They remain one of the best ways for many people to maximize the tax benefits of charitable giving.
Contributions to DAFS increased by 80% from 2015 to 2019, according to the National Philanthropic Trust (NPT). Grantmaking from DAFS increased by 93% during that period. The NPT says every key metric about DAFs increased for 10 consecutive years.
A DAF is created or sponsored by a charity. For a long time DAFs were little-known vehicles operated by local, regional, and a few national charities. They began to take off in the 1990s after a charity affiliated with Fidelity Investments created the Charitable Gift Fund. Now the charitable arms of most major brokerage and mutual fund firms sponsor DAFs, with the largest organized by Fidelity, Schwab, and Vanguard.
The DAF gives everyone many of the tax and charitable giving advantages previously available only to those wealthy enough to set up private foundations. Now, planned charitable giving is low-cost, national, and convenient. In fact, many wealthy people now opt to use DAFs instead of incurring the costs and time in establishing a foundation or charitable trust.
The 2017 tax law made it more important for many individuals to bunch several years of charitable contributions in one year. The law doubled the standard deduction amount and reduced many itemized expense deductions. The result is few people now itemize expenses on their tax returns, so they receive no additional tax benefit from charitable contributions.
You might be able to itemize expenses when you bunch the expenses in one year. A way to do that is to make several years’ worth of charitable contributions to a DAF one year and then distribute the money to charities over the next few years or on whatever schedule you want. Some people use a DAF because they want the tax deduction today but want to let investment returns on the money compound tax free for a while so they can make larger charitable contributions in the future.
Another big advantage of the DAF is you can take one large charitable deduction when it makes sense for you. Then, you can take your time deciding which charities receive the money.
You might want to make a large gift in a year when you have unusually high income, say from a bonus or from selling an asset with a large capital gain.
The DAF also can be used as a tax-efficient way to dispose of an asset in which you have a large gain. Instead of selling it and incurring the long-term capital gains taxes, you can donate all or part of the investment to the DAF. You receive a charitable contribution deduction equal to the current market value of the asset. You don’t pay taxes on the capital gain.
To use a DAF, the taxpayer opens an account with the DAF and makes a contribution. The contribution qualifies for an immediate charitable contribution tax deduction. Money in the account usually is invested according to the donor’s choices from among investment options offered by the DAF.
Donations to qualified charities are made from the DAF according to directions from the donor. The donor chooses the charities plus the amounts and dates of the gifts. You might be able to advise the DAF to make contributions over the telephone or online. Or the DAF might give you a checkbook, allowing you to issue checks directly to the charities. You can make it appear you have a private foundation through the name printed on the checks, such as “Max Profits Charitable Trust.”
Technically, these are “donor-advised” funds, so you’re only making a recommendation to the DAF. But so far DAFs have made the recommended contributions as long as they are to IRS-approved charities.
Though you have an account in your name, the money no longer belongs to you and you can’t get it back. The account value can only be donated to IRS-qualified charities.
Unlike private foundations, DAFs currently have no minimum annual giving requirement. But there’s a proposal in Congress that would require DAFs to donate a minimum amount to charity each year so the donors couldn’t take tax deductions years before charities receive any benefit from the money.
Also, DAFs can be private. The donations aren’t publicly reported. Some wealthy people have adopted DAFs instead of private foundations for this reason.
You receive the tax deduction when you donate to the DAF, even if the money isn’t donated to charities until future years.
Deductions of cash contributions generally are limited to 60% of your adjusted gross income (AGI) for the year, though a special rule allows deductions of cash donations of up to 100% of AGI in 2020 and 2021. The deduction limit for contributions of long-term capital gains property usually is 30% of AGI. Don’t forget to consider the effects of the alternative minimum tax when planning how much to give. Check with a tax advisor to verify the limit that applies to you and the type of property you donate.
Most donor-advised funds allow you to start with $5,000. You can choose one of the DAFs sponsored by financial services companies or seek out a DAF sponsored by a local charity, coalition of charities, national charity, or a university.
You can learn of many local and regional DAFs at www.cof.org by searching for “community foundation locator.” DAFs sponsored by a charity or focused on a region usually require a minimum percentage of the contributions to be made to the associated charities.
Of course, compare fees and expenses. They won’t reduce your charitable deduction, but they will reduce the amount of money that’s available to give. Also, examine any giving limits. Some funds limit the number of individual contributions you can make or checks you can write each year without incurring additional expenses. There might be a minimum individual donation amount, and a minimum account balance might have to be maintained.
Determine if there are restrictions in the types of donations a DAF will accept. Most of the DAFS, even those sponsored by financial services companies, will accept many kinds of assets in addition to cash and securities, including real estate, art, and limited partnerships.
The DAF has a lot of control once it receives assets. In one recent case, a DAF received a large block of shares in public stock that was thinly traded. Instead of selling the stock gradually as the donor said he directed, the DAF sold the stock in a two and one-half hour period and the price declined by 30%. This reduced the donor’s tax deduction and the amount available to donate to charity, but a court ruled the DAF had discretion over the assets and wasn’t bound by any oral promises the donor said he received.
You can make the DAF a family activity. Family members can gather periodically to discuss which charities should receive gifts. Or you can give each child discretion over a DAF account or an amount of the account.