Most everyone has heard of the Clinton Foundation, as well as the largest private foundation in the U.S., the Bill and Melinda Gates Foundation. But there is a rapidly growing way for other affluent donors to benefit their favorite charity (and get a tax break at the same time) without the costs and hurdles of establishing a family foundation. (For related reading, see: How to Start Your Own Private Foundation.)
How to Establish a Donor Advised Fund
A donor advised fund (DAF) is a philanthropic tool established to benefit charity. Some liken the DAF to a charitable savings account. Donors make a charitable contribution to the DAF and receive an immediate tax deduction for that year. Subsequently, the donor then recommends grants from the fund, which can be over a long period of time. Establishing and operating a DAF is relatively simple:
- You establish the name of your DAF account and name its advisors and charitable beneficiaries. You, and others, can make additional contributions to your DAF. The DAF can go on for years after you are gone if you so desire.
- You can make contributions of personal assets—e.g. cash, stocks, bonds, real estate, even art—to the DAF.
- You immediately receive the maximum tax deduction up to the IRS allowance. That is up to 50% of your income for cash donations and 30% for other assets, and there can be a carryover into future years of excess amounts.
- Your contribution is placed into a DAF account where it can be invested and can grow tax-free.
- Any time after the contribution into the DAF, you can recommend grants from your account to be made to qualified charities.
You cannot ever get back any of the funds you donate into your DAF, nor can you personally benefit from the grants from the DAF.
Why 2016 Is a Good Year to Start a DAF
2016 could very well be a great year to establish your donor advised fund because there is much talk about income taxes being lowered by the next administration. For example, let’s say that a couple is currently in the 39.5% tax bracket and that they usually donate $10,000 each year to charity. That means in 2016 their $10,000 donation would save them $3,950 of federal income tax this year and state tax too. The proposed tax rate next year would be lowered to 32.2%, so their $10,000 contribution next year would save them only $3,220 of federal income tax.
If they established a DAF in 2016 and put $50,000 into the fund, their deduction would be at the 39.5% rate. Their tax savings would be $19,750. If, as usual, they gave $10,000 a year to charity, with the proposed lower tax rate for the next four years (for a total of five years) their tax savings would be $16,950. That couple would have saved roughly $3,000 more in federal taxes by establishing the DAF and making their donation in 2016, and giving grants to charities over the next five years from the DAF. (For related reading, see: Cut Your Tax Bill With Donor Advised Funds.)
Other affluent folks interested in charity who could benefit from this type of giving are those that find themselves with much higher income than usual. This might be due to the sale of a business, sale of company stock options, a huge bonus or the sale of real estate, among other things.
The Best Types of Assets for a DAF
The best type of assets to put into the DAF are highly appreciated assets where capital gains tax would be due if the asset were sold. For example, one woman worked for a company and had bought company stock over her years employed there. Her cost basis for the company stock purchase is $10,000 but the stock is worth $110,000. If she were to sell the stock to be able to give the cash to charity, she would have a minimum of $15,000 in federal tax and that amount could be as high as $23,500, depending on her situation. But if she gave the stock to the DAF she would not have to pay tax on the gain and the charities that she favors have more while she saves on income taxes. (For related reading, see: What You Need to Know About Capital Gains Taxes.)
DAFs are established with an organization that qualifies as a charity. This could be one established in conjunction with an investment company such as Fidelity, Vanguard or Charles Schwab. Or it could be one that is designed to benefit an institution of high learning or a religious group. Other organizations could be designed to help charities in a geographical area. Working with a national organization provides the benefits of grants to both national and international charities, moreover, they are generally experienced in dealing with complex gifts and they have a greater investment selection. Two of the largest are National Philanthropic Trust (NPT) and American Endowment Foundation (AEF).
If you regularly give to charity and are in a high tax bracket, the DAF could work well both for you and your favorite charities. So, while there’s still time in 2016, consider establishing a DAF now and making a contribution. (For related reading, see: Donor Advised Funds: The Benefits and Drawbacks.)