Donor-Advised Funds: Making Year-End Giving Strategic, Easy, Tax Smart

October 19, 2012

Rande Spiegelman
CPA, CFP®, Vice President of Financial Planning, Schwab Center for Financial Research

As year-end holidays and tax deadlines approach, charitable giving can be unplanned, difficult to organize and rushed. But with proper planning, it's possible to realize charitable giving goals while reaping potential tax benefits.

The growing popularity of donor-advised funds (DAFs) isn't surprising. Accounts can start as low as $5,000 or as high as $1 billion and deliver tax benefits for a wide range of gifts—from cash and appreciated securities to closely held shares and property. One of the most notable features of DAFs is how they uncouple the timing of the charitable tax deduction from the granting, which lets donors make one tax-deductible contribution at year-end and grant to charities of their choice on their own schedule. DAFs also allow donors to maintain a level of privacy around their giving if they desire.

A simpler alternative to private foundations

Simply put, a DAF is a charitable account opened in the name of one or more individual donors and held in custody by a nonprofit—typically a charitable organization founded by a financial services company, a community foundation or a university. The donor decides when and how much to contribute to the account and can direct grants to 501(c)(3) charities that are in good standing with the IRS. The custodian vets charities for IRS eligibility and sends out grants at the donor's request. The custodian also manages the investment of the charitable assets based on guidance from the donors. Some custodians offer a choice of investment pools and allow independent investment advisers to manage the assets of larger accounts. The custodian is responsible for the recordkeeping, which is usually consolidated online, allowing donors to easily access a list of all of their contributions and grants for tax purposes, thereby enabling a strategic approach to philanthropy.

DAFs are a much simpler alternative to private foundations, which often require more administrative duties. Private foundations must create and manage a board of trustees, hire administrators, file increasingly accessible public documents, ensure annual disbursements meet the IRS requirement of 5 percent of foundation assets and pay excise taxes on investment income.

Upon opening a DAF account, incremental gifts can start at $100 and there are no annual disbursement requirements or public filings. Grants start as low as $50 and can be acknowledged or anonymous (a feature valued by those who want to avoid publicity or further solicitation). Administrative fees are typically less than 1 percent of assets under management (less than 0.6 percent at the largest custodians) and lower for the largest accounts.

Source: www.irs.gov 

Unique tax advantages

DAF contributions carry measureable tax benefits and are eligible for an immediate tax deduction. Cash contributions to DAFs are deducted up to 50 percent of adjusted gross income, higher than the 30 percent maximum for contributions to private foundations. Gifts of appreciated assets, such as stocks, are deductible up to 30 percent for a DAF, but only 20 percent for a private foundation. Both enjoy a five-year, carry-forward provision for excess deductions.

Contributions of appreciated securities with unrealized long-term capital gains (including IPO shares after restrictions are lifted) carry an additional tax benefit, as they enable donors to avoid capital gains taxes associated with the sale of these types of securities. This is an increasingly attractive benefit, as many donors have a portion of their portfolio in appreciated assets and they may want to consider donating them before donating cash.

Investors holding low-cost-basis stock with a capital gain of $100,000 would face a $15,000 federal tax bill if they sold their shares. By donating the stock to their DAF, they can avoid this capital gains tax on the sale, have the full $100,000 value go to charity and realize a $28,000 charitable income tax deduction (assuming 15% capital gains tax rate and 28% tax bracket).

Extracting value from illiquid assets

The advantages of contributing appreciated assets to a DAF are not limited to publicly traded securities. Increasingly, DAFs accept less liquid assets, including restricted and unrestricted stock; privately held securities such as private equity, certain corporate stocks and pre-IPO shares; tangible personal property; and the cash value of life insurance policies and real estate.
Donations of less liquid assets are more complex. The DAF custodian will need to outline how the shares will be turned into cash, which can then be disbursed to charities.

The IRS also requires independent appraisals to be conducted for all non-cash gifts worth more than $5,000, so gifts of these types of assets often need to be larger than cash minimums to justify the time and expense. Still, the largest DAF custodians have become known for their ability to accept illiquid assets and provide charitable value to their donors.

Building a charitable legacy

DAFs are designed to make it easy for donors to bequeath their account and enable others to support charitable causes after their passing. Many donors take comfort in knowing that the contributions they make to their DAF may allow a surviving spouse, child, close friend, trustee or other family member to make grant requests to charities they value. In doing so, they pass their commitment to philanthropy on to the next generation. Some DAF custodians also allow donors to recommend a recurring gift to their favorite charities after their passing.

DAFs are also increasingly used as a part of a well-executed estate plan, since assets donated to a charitable account are not part of a taxable estate. There are several tax-smart ways to add to DAFs at death, including designating a DAF as a beneficiary of a retirement plan, revocable or living trust, charitable trust or life insurance plan.

—Originally published in CalCPA’s September 2012 issue of California CPA.