Many people like doing good by donating to worthy causes. But what if you could maximize your contribution to world-benefitting causes and save money on taxes at the same time?
That’s the idea behind donor-advised funds. Donor-advised funds are becoming a big part of charitable giving, with more than $250 billion in charitable assets in 2023, according to the National Philanthropic Trust.
So, what is a donor-advised fund and could it help you save money on taxes while making a positive difference? Let’s take a look at the details.
What is a donor-advised fund?
Donor-advised funds (DAF) are set up as separate investment accounts by what the IRS calls sponsoring organizations. The organization operating the donor-advised fund account must be a 501(c)(3).
Donor-advised funds accept contributions and invest the funds to grow assets. Later, they make “grants” to charities recommended by their donors. It’s important to note that the money is out of your hands once you contribute to a donor-advised fund. However, most funds provide a form you can use to suggest a grant for your preferred charity.
Depending on the fund, the charity will receive a check or transfer of assets. When that happens, the fund might include a note to the charity indicating you were the donor. Sponsoring organizations are responsible for vetting the charities suggested by donors and making sure that they meet 501(c)(3) tax-exempt requirements.
Basically, it makes it easy for you to make a tax-deductible contribution to multiple charitable causes because you can make one contribution and have it distributed to multiple charities.
How to establish a donor-advised fund
A DAF must be operated and maintained by a 501(c)(3) sponsoring organization. So, if you want to establish one, you must go through the process of creating a compliant organization. It must be separate from your other accounts.
An easier way to take advantage of DAF giving is to use already established organizations. For example, there are three main types of funds available:
- Single-issue: Some charitable organizations create their own funds designed around a specific cause or mission.
- Community foundation: Give to a DAF established to benefit local charities. You can advise on which local charities receive a portion of your contribution.
- National DAF through a brokerage: Some major investment brokers offer their own donor-advised giving accounts. Two examples are Fidelity and Schwab. Both have set up 501(c)(3) charitable organizations to manage DAF giving. You can set up an account and contribute.
By giving to an already-established organization, you get the benefit of contributing to a donor-advised fund, but you don’t have to go through the process of getting the correct IRS designation and managing governance.
Make tax-deductible contributions to the donor-advised fund
Contributions to a DAF are tax-deductible. There are two main approaches to making donations to a donor-advised fund:
- Cash and checks: When you contribute with cash or a check, you can usually claim a deduction of up to 60% of your adjusted gross income (AGI).
- Stocks and other appreciated assets: You can also donate securities to a DAF. When you do so, you don’t normally have to pay capital gains taxes on the appreciation. Depending on the fund, it’s also possible to donate alternative assets, such as private business interests and cryptocurrency. On top of that, you can usually claim a deduction of 30% of your AGI for appreciated assets.
You receive your tax deduction in the year you contribute to the DAF. Your tax advisor can help you understand the implications and determine what you’re eligible for.
It’s important to note, however, that your donation to such a fund is irrevocable. Once you give that money, it’s out of your hands. The organization controls the money. The reason this works is because you’re technically donating to a 501(c)(3) charity through the sponsoring organization.
Give without capital gains taxes
Money in a donor-advised fund is usually invested. The idea is to grow the assets in a way that allows the DAF to give to more charities later. You generally have the ability to advise the fund about what assets you want included as part of your account. However, the sponsoring organization has control over the money.
When you’re ready to give, you advise the fund of where you want the money to go by letting them know which charity you prefer. Many sponsoring organizations, including national brokerages that have charitable arms, have you fill out a form designating the amount you want to donate. The fund then distributes the requested donation to charities, making sure they meet the requirements. If the fund you donate to doesn’t list your preferred charity, you can advise them by asking them to add it as a choice.
If assets have appreciated within your giving account, you don’t have to pay capital gains on those assets. However, it’s important to note that you don’t claim a tax deduction on the amount you request be donated to the charity. You’ve already received your tax benefit by making the contribution to the DAF in the first place.
The capital gains tax advantage comes when you donate appreciated assets. Similar to qualified charitable distributions from a tax-advantaged retirement account, you can put assets into a DAF and avoid the taxes that would have come had you sold the assets.
If you’re looking for a charitable giving option that allows for simplicity and might help you save money on taxes, a DAF can be one way to support a cause you believe in.
Add a Comment