10 Years Old – Kind Of
Though the very first instance of something like a modern donor advised fund (DAF) was created in the 1930s, it wasn’t until President George W. Bush signed the Pension Protection Act of 2006 (H.R. 4) that the current framework for this charitable vehicle was finally created. The 2006 Act established:
- The legal definition of a donor-advised fund.
- A list of prohibited payments to donors and advisers to a donor-advised fund.
- New rules about what grants can be made from donor-advised funds.
- The documentation required for all contributions to donor-advised funds.
Over the past decade, donor advised funds have made it increasingly possible for individuals and families of more modest means to plan and manage their charitable giving in a way that was once only possible by larger charitable foundations. Could a donor-advised fund be right for you?
How Do They Work?
Donor advised funds operate much like private foundations. Individuals can contribute either cash or appreciated securities to the fund and receive a tax deduction for the full fair market value of the asset on the date of the transfer. Once received, any non-cash contributions are liquidated by the sponsoring organization of the fund, and the cash is placed into one or more pooled investment accounts or into an individually managed portfolio on behalf of the original donor. The donor can then use these funds to make cash gifts to one or more charitable organizations. The gifts can be made either all at once or over time. When a donor wants to make a specific gift, she simply sends a request to the sponsoring organization, which then sends a check directly to the charity on her behalf. This ability to separate the donor’s tax deduction from the charitable gifts themselves is one of the most powerful features of DAFs.
Ms. Smith’s Tax Solution
What are the practical benefits of a donor advised fund? Take, for example, Abagail Smith, who owns $40,000 of Apple stock with a basis of $10,000. Abagail normally makes an annual gift to each of several charities whose work she wants to support. This year, however, her tax advisor has suggested that she accelerate as many of her charitable deductions as possible into the current tax year in order to offset a large taxable bonus she has received. Abagail thinks this is a good idea in general, but rather than use cash she would like to use her appreciated Apple shares to fund the contributions because it is so much more tax efficient. Still, she isn’t looking forward to the administrative hassle of making individual stock transfers to the charities in question, and she doesn’t know if all of them are even in a position to accept appreciated stock. In addition, she isn’t sure that accelerating the contributions themselves into a single year is the best approach to funding the charities’ ongoing operations. Nor is she happy about losing the flexibility to change her mind about her future gifts, with regard to both the amounts and the target charities themselves.
So rather than make individual stock transfers, Abagail establishes an account at a donor advised fund and transfers her $40,000 of Apple stock to the sponsoring organization. She will receive a $40,000 tax deduction on her current year’s income tax return and avoids capital gains on the sale of the shares. The sponsoring organization then sells the Apple shares and invests the proceeds on her behalf. Later on, Abagail requests a $4,000 contribution to each of several charities for the current year, which the sponsoring organization completes. Next year, Abigail is free to add to or change the list of charities she wants to contribute to. She can also change the amount she wants to contribute. If she doesn’t distribute all of the money in the fund in the near term, the balance in her account will stay invested and can earn a tax-free return, which she can also use for charitable purposes.
What are the advantages of a donor advised fund?
Donor advised funds offer three important advantages for the charitable-minded individual:
Administrative Ease. Since donating mutual fund shares is more cumbersome than donating cash, some donors elect to use cash to fund small- to mid-sized donations rather than using appreciated securities. Clients who want to use appreciated securities to fund a number of smaller gifts can do so very easily by going through a donor advised fund.
Tax Benefits. A donation of appreciated long term capital gain property offers both a tax deduction for the value of property contributed to the fund and the elimination of the capital gains tax on the appreciation built into the donated security.
Timing of Deductions. Donors who wish to deduct multiple years of charitable deductions in one tax year may find the donor advised fund structure appealing. For example, donors who have one high income tax year followed by a number of lower income tax years may wish to use a charitable fund to accelerate their charitable deduction into a single tax year. Grants can then be made out of this fund to various charities over subsequent years.
How to Set Up a Donor Advised Fund Account
Over the past decade it has become quite easy to find a donor advised fund to work with. Several major custodians (e.g. Fidelity, Schwab, etc.) have sponsored DAFs. In addition, many community-based charities offer donor advised fund options in addition to direct giving opportunities. If you work with a financial advisor, they can often also work with a national sponsoring organization to set up a DAF for you. Griffin Black, for example, works with the American Endowment Foundation to set up and manage donor advised funds for clients who are interested in taking advantage of this charitable tool.
Now that doing good has become easier and more tax efficient, a donor advised fund may be something that you too could consider.