Charitable givers sometimes establish private foundations to manage their philanthropic activities. But foundations are costly to set up and subject to excise taxes, minimum distribution requirements and other regulatory requirements. If you are looking for a more cost-efficient vehicle for leaving a charitable legacy, consider a donor-advised fund (DAF).
Tax Cuts and Jobs Act provides a boost
DAFs are particularly valuable in light of changes made by the Tax Cuts and Jobs Act (TCJA). By nearly doubling the standard deduction, eliminating miscellaneous itemized deductions, and limiting deductions for state and local taxes and certain mortgage interest, the Act reduces the number of taxpayers eligible to itemize. Now, some taxpayers need to donate more in a given tax year to benefit from charitable income tax deductions.
One strategy for maximizing deductibility without increasing your overall expense is to “bunch” charitable contributions in alternating years. A DAF allows you to make substantial deductible contributions in one year without the need to identify a specific charitable beneficiary or send them the funds right away.
Related Read: Deduct Now, Donate Later: Donor-Advised Funds Offer Significant Benefits
How it works
A DAF is an investment account — similar in many ways to a mutual fund — that accepts tax-deductible contributions. A “supporting organization” sponsors the fund and you advise the sponsor where you want your charitable dollars to be distributed. To comply with tax regulations, the sponsor must have the final word on how your funds are used. But in practice, DAFs usually follow your recommendations.
Like private foundations, contributions to DAFs are immediately deductible (subject to income limits), but DAFs offer several advantages over foundations, including:
- Lower Cost, Easier Setup
Unlike foundations, which typically have substantial start-up costs and take months to set up, a DAF can be established in the time it takes to open a mutual fund account, often with a minimum contribution of $25,000 or less.
- Fewer Administrative Burdens
Running a foundation requires you to appoint a board, hold regular meetings, keep minutes and file separate tax returns. A DAF’s sponsor handles most administrative duties.
- No Excise Taxes
Foundations are subject to excise taxes on their net investment income and must pay additional excise taxes if they fail to meet minimum charitable distribution requirements. DAFs are not subject to these taxes.
- Higher Deduction Limits
Currently, cash contributions to DAFs (together with other cash donations to public charities) are deductible up to 60% of adjusted gross income (AGI), and noncash contributions are generally deductible up to 30% of AGI. For foundations, these limits are 30% and 20%, respectively.
It is easier for contributors to DAFs to remain anonymous.
The most important advantage of a private foundation is control. When you establish a foundation you remain in full control over management of the foundation’s investments and distribution of its funds. Assets contributed to a DAF become the sponsor’s property and you are limited to an advisory role (although, as previously noted, the fund usually follows your advice). A foundation can also be a great vehicle for getting your family involved in charitable activities. It can even hire family members and pay them a reasonable wage for their services.
Keep an eye out
As you weigh the pros and cons of DAFs versus private foundations, be sure to monitor developments in Congress and state legislatures. From time to time, legislation is proposed that would impose additional restrictions on DAFs or curtail their benefits.
For more information, contact Adam Pechin at [email protected] or 312.670.7444. Visit ORBA.com to learn more about our Wealth Management Services.