How to Use a Donor-Advised Fund to Minimize Taxes and Maximize Charitable Gifts

How to Use a Donor-Advised Fund to Minimize Taxes and Maximize Charitable Gifts
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Being fortunate enough to use your financial resources to give charitably is a gift in itself. And if you are lucky enough to have reached this point in your financial journey, you have several options when considering how charitable giving fits into your financial plan.

A donor-advised fund (“DAF”) can be part of a comprehensive strategy to maximize your decision on how, when, and where to give while keeping things simple and efficient. It is important to determine your own unique goal in your charitable giving; create a plan, and adjust to changes. Remember: what feels right to one person may not necessarily work for another.

When it comes to giving, the choices available can seem overwhelming. Donor-advised funds have an advantage as they are a simple, tax-efficient way to give to a broad array of charities. DAFs are the catch-all of charitable giving; you get all the benefits without the complexity.

The Gift of Giving

It is heavily ingrained in American culture to value charitable giving, and we’re incentivized to do so with income tax advantages. According to Charity Navigator, charitable giving made up 2.1% of GDP in 2017, and even during the pandemic of 2020, charitable giving amounts rose.

The majority of charitable giving is done by individuals, who in turn receive a tax deduction when itemizing deductions to give a dollar-for-dollar reduction in taxable income. As the donor, you have control of where and when the funds are given to charity.

Gifts can be made in cash, but if you want to get the most out of your charitable gift, donating appreciated property, like stocks or other securities, can give you additional benefit. Once you move funds to your donor-advised fund, you may claim a tax deduction immediately if you are itemizing.

Options for Donor Advised Funds

How a Donor-Advised Fund Works

A DAF is a 501(c)3 public charity. It serves as a conduit that is very helpful in receiving gifts of appreciated property. Some DAFs even accept property like artwork, business interests, real estate, life insurance or other more illiquid assets.

A significant financial planning advantage to utilizing a donor-advised fund is tax centric. The minimum amount to start a DAF varies based on where you are opening your account, with some like Fidelity Charitable and Schwab Charitable having no minimum initial contribution or balance requirements.

You may opt to contribute cash, securities, or illiquid assets to your donor-advised fund. Once you determine the amount you would like to start the account with, there is no reversing the decision once the money is in the account. The gift to the donor-advised fund is irrevocable. You can also add to the account over time.

Let’s look at a case study for better clarification:

  • Isabel wants to support 5-10 charities each year in different amounts. Some are small charities that do not have a brokerage account to receive gifts of stock.
  • Isabel set up an account at a DAF. She gave shares of Apple stock that had grown in value to the DAF as an irrevocable gift, and she received a tax deduction for the charitable gift to the DAF.
  • The DAF sells the stock as soon as it is feasible, and the funds are available to Isabel to recommend as a grant to another 501(c)3 charity. Isabel can recommend “grants” to one or multiple charities at any time.

Donating Cash vs. Donating Securities

When donating cash to a 501(c)3 charitable organization, you can deduct 100% of the amount that you give if you are itemizing your deductions. If you donate an appreciated asset that has been held longer than a year – such as a stock – to a charity, you can receive a deduction in the amount of the fair market value on the date of the gift up to certain limits.

What makes the donation of stock more appealing is that the gain on the sale is also not taxed to you as capital gains.

How does this work?

  • Isabel wants to support a local charity that she has researched. She has cash available, but she also has 50 shares of Apple stock that she bought in 2017. Since she bought it for a much lower price, if she sold it, she would owe capital gains taxes on the gain.
  • Let’s assume that she bought the 50 shares of stock for $2,000 total and that it is now worth $7,000. The gain is $5,000, and at the 15% capital gains tax rate, she would owe $750 in taxes if she sold it.
  • Instead, Isabel gives the 50 shares of Apple directly to the charity. She gets a tax deduction for $7,000 and effectively saves an additional $750 by not paying capital gains. By the way, the charity does not have to pay capital gains taxes either.
  • She itemizes her taxes and is able to deduct the $7,000 gift. At the 32% tax bracket, this gift saves her $2,240 on her federal taxes in addition to the $750.

Benefits of Using a Donor-Advised Fund

Tax Planning

The biggest advantage to contributing to a donor-advised fund is the tax deduction. Your contribution to the fund acts as though you made a gift to a 501(c)(3) charity recognized by the IRS.

Having a separate vehicle for charitable donations also allows for more efficient tax planning. For example, in years of higher income, one could make a larger contribution to the fund to offset income and can spread eventual grants to specific charities over multiple years.

If President Biden’s proposals in the American Families Plan for a loss of step-up in cost basis at death and higher capital gains tax rates is enacted into law, DAFs will likely be utilized even more.

Ease of Use

The donor only has to keep up with a single tax receipt from the DAF regardless of how many grants to individual charities she makes.

Cost Efficiency

DAFs can be used in place of setting up a private foundation meant for leaving a longer-term charitable legacy. While there are benefits to both structures, a DAF is typically easier and cheaper to administer. Funds can be set up with multiple and successor account holders, which accomplishes legacy giving goals.

Investment of Funds

Gifts to a DAF can also be invested for long-term growth and grow tax-free, which also enhances the ability to leave a charitable legacy. There is no requirement to distribute minimum percentages of the fund in any year.

Foster a Family Culture of Giving

Setting up a family fund can be an easy way to foster discussions with children of all ages and to involve them in decision making. Extended families can also come together to make charitable grants.

When Does it Make Sense to Use a Donor-Advised Fund?

Depending on your or your family’s tax planning or charitable goals, a donor advised fund can be a helpful tool to maximize your financial assets and accomplish more complicated planning goals while easing administrative burden.

Stay on top of the tax laws and understand the fees associated with the fund. If you have questions, consult a financial professional who can help you structure your charitable giving in a way that benefits the charity as well as you. A fiduciary financial advisor with knowledge of your goals, values, and personal situation can help you make the most informed decision on how best to accomplish this.

If you would like to discuss how Abeona Wealth can help you set up and manage a Donor Advised Fund to streamline your philanthropic giving and ensure you receive the right tax benefits, please do get in touch.

Investment advisory services offered through Equita Financial Network, Inc. an Investment Adviser with the U.S. Securities and Exchange Commission. Registration does not imply a certain level of skill or training. Equita Financial Network also markets investment advisory services under the name Abeona Wealth. Information herein is intended for discussion and consideration and may make a number of simplifying assumptions. Securities investing involves risks, including the potential for loss of principal. There is no guarantee that any investment plan or strategy will be successful. Consult a financial, legal, or tax advisor for specific recommendations for a personal situation prior to implementation.

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