Donor advised fund basics
All said, our clients tend to be a generous bunch. It is no surprise, then, that from time to time we receive questions from them about charitable planning and the donor advised fund in particular. With the giving season upon us along with the year-end, now is a good time to review the particulars of this popular charitable fund.
WHAT IS A DONOR ADVISED FUND AND HOW DOES IT WORK?
Here is a very simple explanation. Think of the donor advised fund as a conduit — or an escrow account of sorts — that takes your donations and disburses them to various charities on your behalf. So, if you’ve got money you wish to give to charity, you could make a donation to a donor advised fund. In turn, this fund will invest your money and make gifts to charities of your choice over time. That’s it. And the great part? Your donation is immediately tax deductible — just as if you made the donation yourself directly to a charity.
To be technically precise, the donor advised fund is not itself a charity. Rather, it’s a fund administered by a public charity referred to as a “sponsoring organization.” Seattle Foundation and Fidelity Charitable are examples of sponsoring organizations. When we refer to donating to a donor advised fund, we really mean donating to the sponsoring organization that administers the fund. For the sake of simplicity, we will use both terms synonymously.
Since the tax rules are the same for both the donor advised fund and your own direct donations, why use the fund? Why not just donate yourself to charities directly?
Strategic and structured giving
The donor advised fund enables you to give in a structured and thoughtful manner. That is, you donate to the fund, which invests your money tax free and strategically distributes it to the charities of your choice over time. It is a planned but essentially hands-free way of giving.
Family meetings are a great way to create a charitable giving plan. These meetings can occur yearly, say at your Thanksgiving gathering, and you can hash out which charities align with your family values and how much you’d like to donate. Meetings like these can help you build a multi-generational family legacy.
Gifting non-traditional assets
When you gift an appreciated asset that you’ve held for more than one year (like stocks) to a charity or a donor advised fund, the tax deductible amount is the value of those stocks — not how much you paid for them. So, if you give $10,000 of XYZ Inc. stock and you paid $2,000 for it two years ago, you get to deduct $10,000, not $2,000. You pay no taxes on the $8,000 long-term capital gain.
But it gets better with a donor advised fund. In addition to publicly traded securities, some larger donor advised funds accept more complex and less liquid assets like real estate and privately-owned businesses. Most charities are not equipped to accept these types of assets.
(Quick note on tax rules: With donor advised funds and public charities, your deduction is limited to 50% of your adjusted gross income for cash contributions and 30% for contributions of appreciated properties like the ones just mentioned. Any amount you don’t deduct this year is carried forward for 5 years. After the 5 years, you can no longer carry it forward, so you lose the deduction. Yeah, it can get a little complicated, so make sure you consult your tax advisor.)
Simple and consolidated recordkeeping
When you donate to a donor advised fund instead of multiple charities, your recordkeeping for tax purposes becomes a whole lot simpler. You need only track one charity instead of many. With a donor advised fund, there is virtually no set-up cost or administrative burden. And there are no separate reporting requirements — tax return or otherwise.
If you want to keep your donations anonymous, you can choose to do so.
The donor advised fund is a wonderfully efficient way of charitable planning, both from tax and administrative fronts. But before you commit your dollars to one, there are a few things you should know.
You can’t control where the money goes
One important technical point about the donor advised fund is that you, as a donor, have the right only to advise, but not control, where your money goes. In other words, your gift to a donor advised fund is irrevocable. You give up control of the gift. Once you make a donation to a donor advised fund, the fund — not you — has the final say in where your money ultimately goes. In practice, these funds tend to respect donor recommendations, although, again, they are not legally bound to do so.
No second deduction
Remember, when you make a gift to a donor advised fund, it’s immediately deductible. So, when the fund makes a gift to a charity, you don’t deduct anything. There is no second deduction. If your donor advised fund investment takes off before it is gifted to a charity and the balance grows substantially higher than the original amount you contributed (and deducted) — no second deduction. If the gift made by the fund turns out to be much larger than your original gift? No further deduction. Once you have donated your gift to the fund and received a deduction, that’s it. There are no more deductions. Some people may find this emotionally difficult to accept (and intellectually difficult to comprehend).
No charitable intent
If you make gifts to a donor advised fund without a true charitable intent — that is, if the tax deduction was the overriding motivation — the fund may become more of a burden than a blessing. Unless you provide a thoughtful charitable strategy to the fund, your money may just sit there. You may have a nagging feeling that something should be done with the fund, while still not feeling overly charitable.
Not all charities are approved
Check with the donor advised fund to determine if your choice of charities is approved, before you commit to donating. While larger charities are generally approved, smaller ones may not be. If your charity is not on the fund’s approved list, you can request that it be added. If it’s a legitimate charitable organization, they typically oblige.
A WORD ON PRIVATE FOUNDATIONS
While the donor advised fund is a fabulously efficient vehicle for charitable planning, you might be wondering about a private foundation and how it differs from the donor advised fund. Suffice it to say that it’s a lot more involved and expensive. As such, it’s generally best suited for a strategic family philanthropic planning involving a large amount.
High start-up costs
Legal fees and other start-up costs can be substantial for the private foundation, and it can take several weeks to a few months to create. There is typically no cost to the donor advised fund and it can be established immediately.
High administrative costs
There are annual tax returns, independent audit, board and other management and administrative requirements for the private foundation. There are none for the donor advised fund.
Less advantageous tax rules
Cash gift limit is 30% of adjusted gross income (vs. 50% for the donor advised fund). Property gift limit is 20% of adjusted gross income (vs. 30% for the donor advised fund).
There is excise tax on net investment income, but none for the donor advised fund.
You (donor) control the gifting. With the donor advised fund, you can only recommend gifting.
The private foundation must expend 5% of net assets annually. None for the donor advised fund.
The private foundation must file a detailed and public tax return that includes information on grants, staff salaries, fees, etc. A donor advisor fund donor can choose to be anonymous.
All in all, if you want a structured and efficient way to carry out your charitable giving, a donor advised fund may be the way to go.
Originally published on November 24, 2015.
Advisory services are offered by Joslin Capital Advisors, LLC, an SEC Registered Investment Advisor.