In 2014, Americans gave over $358.4 billion dollars in donations to charities. Of that amount, more than 3% of all charitable gifts were made into donor-advised funds. A donor-advised fund, also known as a “DAF”, is administered by a public charity and manages charitable donations on behalf of individuals, families, and organizations. Having a donor-advised fund account is like having a charitable savings account. Many individuals and families have found donor-advised funds to be more cost-effective than operating a private foundation, and provide more flexibility and control than an outright gift to a charitable organization.
How to Fund
To create a donor-advised fund, the donor opens an “account” with the sponsoring public charity. The donor makes an irrevocable initial donation into the account. The donation can be cash, securities, or any other type of financial instrument. The donor has relinquished ownership of the asset placed in the account in compliance with the IRS’s charitable gifting regulations. For tax purposes, the donor receives the maximum tax deduction immediately; however, the donation many not be distributed, in full or in part, to a charity or charities for years.
The donor retains the right to determine how the funds are invested. The donor also has the right to name advisors and successor advisors. Ultimately how much, when, and to which charity or charities the funds are distributed is determined by the donor and/or his or her successor advisors. If the donor wants to make future contributions, they can be made into the same account. These contributions are also immediately deductible even though the funds may not be distributed until far into the future.
The first donor-advised fund was The New York Community Trust formed in 1931. Officially, Congress did not begin regulating these funds until 1969. A study by the National Philanthropic Trust found that 95.4% of American households gave to charity in 2013. The same study found that individuals are responsible for 72% of all charitable giving. In the United States alone there are 1,536,084 registered charitable organizations. The most recent data available from the National Philanthropic Trust regarding donor-advised funds is for the year 2012. At that point there were 201,631 donor-advised fund accounts in the United States. Those funds held $45.35 billion in assets. Based upon 2012 data, over $13.71 billion dollars were contributed to donor-advised funds. The funds made donor recommend grants in the about of $8.62 billion to charities in 2012. The average donor-advised fund account held $224,921.
Why contribute to a Donor-Advised Fund?
The reasons donors give to charities are as diverse as the donors themselves. In another study by the National Philanthropic Trust, it was found that 62% of high net worth donors cite “giving back to the community” as their chief motivation for giving. There are also many tax based reasons for charitable giving. In order to claim a deduction for a charitable contribution under the IRS’s rules you must make an “irrevocable” contribution. If you are writing $1,000 check to your favorite local charity on whose board you sit, the concept of irrevocable probably doesn’t concern you. The gift is relatively small, and you are probably aware exactly how the money will be used. The more zeros you add behind the dollar sign, the more likely it is that you are going to want some control over what happens with your donation. The problem is the more control you retain over the donation the more likely it is your gift could be scrutinized by the IRS.
The traditional alternative for donors who wished to actively manage their charitable giving rather than just write checks was the formation of a private foundation. A private foundation is a nonprofit organization which is created and funded by an individual, family or organization. The funds and programs sponsored by the private foundation are then managed perpetually by trustees or a board of directors which are hand-picked by the founder. The IRS is not fond of private foundations. The Service views the level of control retained by the original donor over the assets and distributions as running afoul of the principal of an “irrevocable” donation. Private foundations are heavily regulated and closely watched. The regulations contain control rules on oversight and minimum annual payouts. In addition, while the thought of having your own private foundation may have appeal much like having your own personal jet, the cost of establishing, staffing, and keeping your private foundation legally compliant can be as prohibitive as maintaining a private jet.
If you are charitably inclined, the use of a donor-advised fund is an excellent way to leverage the power of your charitable gift. For example, you are considering making a large gift to your favorite charity. You believe in the charity’s cause, and want to give back. You have the financial capability to make the gift. Also, your financial advisor, accountant, and attorney have all suggested it is time to begin to divest some of your wealth for tax reasons.
Strategy One - Traditional Giving
In order to fund the gift you need to liquidate assets. You sell stock you purchased, and have held for 10 years which has done well, really well. You paid $10.00 per share (your cost basis.) It is now worth $100.00 per share. You own 1,000 shares. Assume capital gains on the transaction are 15%.
If you sell the stock to make the gift, the gift will be $78,500. You will pay the IRS $13,500 of capital gain tax on the $90,000 capital gain.
This is a hypothetical example and is not representative of any specific investment. Your results may vary.
Strategy Two - A New Approach
You donate the 1,000 shares of stock to the donor-advised fund. The DAF either holds or liquidates the asset. This is your choice. If you do elect to direct the DAF to liquidate the stock, as a public charity it avoids the $13,500 capital gain tax. Thus the gift is maximized to $100,000.00. If the DAF holds the securities and they increase in value after the donation but before the liquidation, there are no additional taxes on the added value. Likewise, if the value of the donated asset goes down after the gift, the donor still gets the full charitable deduction of the value on the date the gift was made.
This tax example would hold true if you gave the appreciated stock to a non-donor advised fund 501(c)(3) qualifying charity. The major difference is control. Once the asset is transferred to a traditional charity, unless you have placed restrictions on your gift, you give up all control. Remember, this is a requirement of the IRS. Many donors or the heirs of donors who have restricted their gifts find out later the restrictions were not honored. They are often powerless to enforce the restriction after it has been violated.
If you donate your gift to a donor-advised fund, you and your named successors advise the fund as to how you want the money invested. You and your named successors also advise the fund on when and to what charity or charities you want the proceeds distributed. The donor-advised fund technically has the authority to ignore your instructions. This is why the gift is considered irrevocable under the IRS rules. In reality this rarely happens. Most instances where the wishes of the donor or successor advisors are not honored involve requests to make donations to ineligible entities such as non-certified charities.
While you and your heirs can remain as involved as you wish for a long period of time, eventually your gift will “sunset.” This means that the funds will be added to the general charity pool of the sponsoring organization. Most donor-advised funds charge a 1% administrative fee per year. In exchange, the DAF does all the paperwork associated with keeping the fund compliant. This is far more cost effective than maintaining a private foundation. The administrative fee is in addition to any management fees associated with the investment of the underlying assets. If you are considering a donor-advised fund, sunset rules and fees should be discussed before you invest.
All statistical data came from the National Philanthropic Trust website at www.nptrust.org.
This information is not intended to be a substitute for specific individualized tax or legal advice. We suggest that you discuss your specific situation with a qualified tax or legal advisor.
Investing involves risk including loss of principal.