As we are nearing year-end, many clients are focused on what they can do to reduce the amount of taxes they will owe. One way to reduce taxes and to also assist those in need, is to donate to charity. In addition to simply writing checks directly to charities of choice, a few commonly used vehicles to accomplish both goals are donating through a private foundation, a charitable lead trust or a donor advised fund (DAF). DAF’s are the fastest-growing charitable vehicle because they are the most flexible and efficient way to give.
According to the IRS, a donor advised fund is a separately identified fund or account that is maintained and operated by a section 501(c)(3) organization, which is called a sponsoring organization. Each account is composed of contributions made by individual donors. Once the donor makes the contribution, the organization has legal control over it. However, the donor, or the donor’s representative, retains advisory privileges with respect to the distribution of funds and the investment of assets in the account. A DAF is like a charitable investment account for the sole purpose of supporting charitable organizations that the donor cares about. It allows donors to receive an immediate tax deduction and to recommend grants from the fund over time by making charitable contributions to virtually any IRS qualified public charity. Donors can contribute to the fund as frequently as they like, and then donate whenever it makes sense for them. Funds in a DAF can also be invested for tax-free growth.
Setting up a DAF is quick and easy and creates a streamlined and tax-efficient method of giving. A DAF also helps organize charitable giving and eliminates the worry of recordkeeping and saving receipts.
One strong advantage to setting up a DAF is the ability to employ a tactic known as “bunching”. This allows a donor to set aside several years’ worth of charitable contributions into one taxable year. If a taxpayer typically does not itemize because the standard deduction exceeds the itemized deductions, a few years’ worth of charitable contributions can be made during one year to a DAF, so in that one year the itemized deductions would exceed the standard deduction. Even though the donation to the DAF was made in one year, the DAF enables the donor to pace the actual donations to charitable organizations over time, while still reaping this significant tax benefit.
Other advantages to setting up a DAF include:
- Instead of donating cash, a donor can donate appreciated long-term securities, mutual funds and ETFs. The donor gets to claim the fair market value of the contribution as a deduction. In addition, the donor will not be subject to capital gains tax on the appreciated portion of the contribution. What’s more, if securities that are held for more than one year are gifted to a donor advised fund, once the stock is liquidated, the donor can reinvest the funds into any investments offered by the DAF sponsor. Any income on these investments is tax-free, and credited to the individual’s DAF account.
- A donor can gift real property, private stock, and other non-marketable assets with low basis into a DAF. The donor will not incur capital gains tax when these assets are sold, and the cash proceeds convert to philanthropic dollars, which is advantageous from a tax perspective. It is important to first make sure that the DAF being used is capable of accepting these non-marketable assets.
- Crypto-currencies are another financial vehicle that can be used to make donations to a DAF. This can be very beneficial, especially if the asset has appreciated in value.
- Donating to a DAF eliminates the expense and burden of making charitable contributions through a private foundation. Private foundations have administrative and reporting requirements. In addition, DAFs report in the aggregate, ensuring confidentiality and protecting fundholders’ privacy, unlike private foundations.
- If a donor is inclined, a DAF can be set up to include a succession plan, which enables donors to extend their legacy of giving to the next generation. In addition, the assets in the DAF are considered outside of the donor’s estate.
A DAF enables individuals and families to achieve their philanthropic goals simply and effectively, with full confidentiality. It is not too late to set up a donor advised fund for 2022. If you are interested in setting one up, please reach out to your LMC professional who can advise as to what your next steps should be.
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