LUTZ BUSINESS INSIGHTS
donor-advised fund + tax benefits
bryan frew, tax director
A Donor-Advised Fund (DAF), defined on Investopedia, is “a private fund administered by a third party and created for the purpose of managing charitable donations on behalf of an organization, family, or individual”. Aside from the obvious philanthropic benefits of such a fund, there are some real tax benefits that can be provided by participating in a DAF.
The main idea of a DAF is to contribute a large sum of money in a given year to help fund multiple charities over several years, all while the undistributed funds continue to grow. The administrative burden is removed from the donor and given to a third party, usually a community foundation. This saves the donor from writing multiple checks to multiple charities every year.
A one-time DAF contribution can be managed by the local community foundation (or national DAF providers and some faith-based institutions) and pass out benefits as directed for years to come. Technically, donors do not have the ability to enforce how the DAF funds are distributed, but as a practical matter, third parties that do not adhere to their donors’ wishes will presumably see future contributions dry up.
Retirement & Tax
Retired individuals can often find themselves in a situation where they are very generous with their accumulated wealth but no longer receive any tax benefit for their donations. This is due to the fact that the charitable giving deduction is limited by adjusted gross income (AGI) and the taxpayer’s ability to itemize on their personal tax return.
Individuals enjoying retirement have less taxable income year-to-year than during active employment years. Less taxable income means lower marginal tax rates and a lower limitation to how much charitable giving can be deducted. Despite the reduction of tax benefits for charitable giving, the desire to give usually increases as individuals with financial security begin retirement. DAFs can be used as a vehicle to reap the tax benefits during high-income years while remaining charitable for decades to come.
The type of tax benefits depends on how the DAF is funded. Recently, the AGI limitation on cash donations has gone from 50% to 60% to 100% in 2021. Most DAFs are funded with appreciated securities that have a 30% AGI limitation. Any charitable giving over the limitations is carried over for up to 5 years. If AGI doesn’t get high enough, the tax deduction times out without ever being used.
For the highest tax benefits, the donor would contribute appreciated securities during the highest-earning year, saving tax at the top rate while avoiding capital gains tax on the donated securities. The benefit to the charity could be spread over many years.
An example of tax savings, assuming current rates and adding 6.5% for state tax, is a taxpayer close to retirement earning $700,000 per year and receiving a deferred compensation payment of $300,000. This taxpayer holds securities of $300,000 with an unrealized gain of $200,000. Not only does the taxpayer deduct the full $300,000 ($130,500 tax savings) of contributed property to the DAF, but also avoids capital gains tax on the $200,000 unrealized gain ($60,600 tax savings).
The taxpayer receives nearly $200,000 of tax benefit for donating securities bought for $100,000. If they waited until retirement to donate the proceeds from the sale of the appreciated securities, the charity would only get a fraction of the original $300,000, and the taxpayer would receive much smaller tax savings due to AGI limitations and a lower tax bracket.
While donating appreciated securities during a high-income year is generally the most beneficial from a tax standpoint, donors can contribute cash or other assets to a DAF. The AGI limitation on cash is higher, but there are no tax savings avoiding unrealized gains. Other assets such as art, real estate, shares of privately held entities, and other “illiquid assets” need to have an appraisal or valuation done to take the charitable deduction. This can be unnecessarily burdensome and expensive.
Also, community foundations would prefer assets that can be readily converted to cash. Donors are effectively surrendering these funds to charitable causes upon setting up the DAF. DAFs cannot compensate family members for services to the fund, the assets can’t be retrieved, and the third party has the final say on how the funds are used. To combat these issues, donors could consider a Private Foundation. For most taxpayers, however, this option would be cost-prohibitive.
The tax savings, administration, and convenience have made DAFs very popular. To maximize the benefits, careful planning must be done. Talk with a tax advisor, a financial advisor, and a local community foundation to see how your family and your community could benefit from setting up a Donor-Advised Fund. If you have any questions, please contact us or learn more about our services.
ABOUT THE AUTHOR
BRYAN FREW + TAX DIRECTOR
Bryan Frew is a Tax Director at Lutz. He began his career in 2009. He is responsible for providing taxation services to businesses and individuals, as well as trusts and estates with a focus on medical practices.
AREAS OF FOCUS
- Individual & Business Taxation
- Estate & Trusts
- Healthcare Accounting & Consulting
AFFILIATIONS AND CREDENTIALS
- American Institute of Certified Public Accountants, Member
- Nebraska Society of Certified Public Accountants, Member
- Certified Public Accountant
- BSBA in Accounting, University of Nebraska, Omaha, NE
- Third City Community Clinic, Past Treasurer
- Volunteer Coach for Youth Sports & Camps
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