Donor-Advised Funds and How They Work
By Bernadette Capriato, Manager, Tax & Business Services
Are there various charitable organizations that you care about and support on a regular basis? Are you making those donations directly to the charity each year? Have you considered setting up a donor-advised fund (DAF)?
Donor-advised funds are simple, flexible and offer several taxpayer advantages. Contributions to a DAF qualify for an immediate tax deduction, which is no different than making charitable donations directly. The advantage is that DAFs are invested and grow tax-free, so you have the opportunity to enlarge the pool of funding you have available for charitable giving without increasing your personal cash outlay. Most importantly, you can make grants from the fund to the IRS-qualified public charities of your choice at any time, so your charitable dollars can continue to grow until you are ready to disperse the grants.
How does a donor-advised fund work?
A donor-advised fund might be compared to a personal charitable savings account. The account is set up with the nonprofit division of an investment company, which serves as the fund sponsor. Donations of cash and/or securities you make to the fund are invested for the exclusive purpose of making charitable grants. These donations are tax deductible to the donor, subject to certain limitations, in the year the donation is made. Grants paid out of the fund to charities of your choice can be made at any time in the current or a subsequent year.
Steps to Set-Up a DAF
- Establish an account with the nonprofit division of a financial services firm, which will serve as the fund sponsor.
- Donate cash to the account and receive an immediate tax deduction for the eligible amount of cash donated.
- The tax deduction for cash donations is limited to 60% of the account owner’s federal adjusted gross income (AGI). This includes all donations made by the donor on an aggregate basis, not just donations made to the DAF.
- If the donation exceeds the 60% AGI limit, the excess can be carried over to the next five tax years, subject to the same limitation. Any unused amount after five years is lost.
- Cash donated to a DAF cannot be returned to the account owner and can be used only to make charitable grants.
- Donate appreciated securities to the account and receive an immediate tax deduction for the eligible amount of stock (bonds, etc) donated.
- The deduction is based on the fair market value of the securities at the time of the donation.
- The securities must be a long-term asset (held more than one year) or the amount of the tax deduction will be limited to the tax basis of the asset.
- The tax deduction is limited to 30% of federal AGI. This includes all donations of appreciated securities made by the donor in aggregate, not just donations made to the DAF.
- If the amount donated exceeds the 30% limit, the excess can be carried over to the next five tax years, subject to the same AGI limitation. Any unused amount after five years is lost.
- The donation of securities also eliminates the capital gains tax that would have been due had the assets been sold at a profit and the cash proceeds donated to a charity directly.
- Once a donation is made to a DAF, it cannot be returned to the donor and can only be used to make charitable grants.
- The fund will invest donated cash and/or proceeds from the sale of securities. Donors can direct the investment strategy or request that a financial investment advisor manage the fund assets.
- Decide which charities you would like to support – church, alma mater or any IRS-qualified public charity.
- Grants that might provide a personal benefit, such as school tuition for a child, are not allowed.
- Grants to political groups are not allowed.
- Recordkeeping for DAFs (as compared to direct charitable giving) is simplified, as the only receipt needed for tax reporting purposes is an acknowledgement of the donation from the fund.
Donor-advised funds provide significant benefits and tax advantages, while allowing the donor to maintain control as to which charities will receive the grants. Donors can take a current income tax deduction for donations to the DAF, while grants from the fund can be made over time while the asset continues to grow.
For questions related to charity planning, contact your Marcum LLP tax advisor.