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It is the holiday season and the best time for charity and good will. If you are among our followers, you already know the basics of charitable contributions and their deduction, a topic we cover regularly in our newsletters.
All in all, what people usually do is select a charitable organization and donate money, property items, and other personal assets. Wealthy Americans may even set up their own charitable foundation, transfer money to it and then give it away over time. But then there is also the donor-advised fund.
A donor-advised fund is a charitable giving vehicle administered by a public charity created to manage charitable donations on behalf of organizations, families, or individuals. Generally, 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.
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A 501(c)(3) organization is a corporation, trust, unincorporated association, or other type of organization exempt from federal income tax. To be tax-exempt under section 501(c)(3) of the Internal Revenue Code, an organization must be organized and operated exclusively for exempt purposes set forth in section 501(c)(3), and none of its earnings may inure to any private shareholder or individual. In addition, it may not be an action organization, i.e., it may not attempt to influence legislation as a substantial part of its activities and it may not participate in any campaign activity for or against political candidates.
The first donor-advised funds were created in the thirties but have relatively recently become the fastest growing charitable giving vehicle in the U.S. and more than 269,000 donor-advised accounts hold over $78 billion in assets.
So what sets a donor-advised fund apart from the other charitable organizations?
A donor-advised fund (DAF) may be set up very quickly and involves little work compared to charitable foundations that require start-up costs, administrative expenses and money-raising soirees.
With a DAF, 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.
To participate in a DAF, a donating individual or organization opens an account in the fund and deposits cash, securities, or other financial instruments. They surrender ownership of anything they put in the fund, but retain advisory privileges over how their account is invested, and how it distributes money to charities.
There is no cost to establish a donor-advised fund, however there are often minimum initial charitable contributions to establish the DAF, typically $5,000 or more.
The donor is the person or persons responsible for making the contribution(s) to the Donor Advised Fund. If the contributions are from joint ownership, then multiple donors can be listed. If the donor wants non-contributors to have grant making rights to the account, they should name those individuals as account advisors.
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The account advisor is named by the donor to recommend grants from the account. An account advisor is usually a spouse, child or relative.
A contribution is complete when the asset is out of the donor's control. The time frame varies depending on the type of asset and when it's transferred to the account. The process usually takes less than two weeks.
Practically, you can take an immediate tax deduction against the full amount you contribute to a DAF, but there are no rules or regulations about how quickly the money actually has to be distributed.
It is worth mentioning that while many charities may not be able to accept complex assets such as real estate, privately-held stock, LP or LLC interests, insurance or even simpler assets such as appreciated stock, you can donate these to a DAF and then the DAF can send checks to the charities. In many cases, donating these to a DAF instead of a private foundation results in greater tax benefits.
A DAF is also advisable if you may not want to donate an entire asset to one charity and may want to split it up among numerous charitable beneficiaries. It is easier to donate this to a DAF and then make separate grants from it. |
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Donors can instruct their advisors to transfer shares of many different stock holdings to one DAF sponsor rather than to many different charities.
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While private foundations are heavily regulated by the IRS, including rules on oversight and minimum annual payouts, donor-advised funds housed in public charities are not subject to the same tax restrictions.
Charitable foundations are subject to an excise tax of up to 2% of net investment gain, including net capital gains and income, while DAFs are not.
If you have appreciated assets, it is perhaps the most tax-efficient way to contribute to a donor-advised fund, since you could realize a double tax benefit: (1) you generate tax savings from the deduction of the donation; (2) you avoid capital gains taxes on the appreciated assets.
Despite their relative efficiency, DAFs have come under fire for the fact that they are not legally required to spend the money they receive and can hold it for as long as they want. Furthermore, the agreements explicitly state that donors cede all legal control of their contributions to the DAF sponsor. Although the sponsors promise that donors will retain control, the fund has the final say in what happens to the money.
Over the years, the IRS has become aware of a number of organizations that appeared to have abused the basic concepts underlying donor-advised funds. These organizations, promoted as donor-advised funds, appear to be established for the purpose of generating questionable charitable deductions, and providing impermissible economic benefits to donors and their families (including tax- sheltered investment income for the donors) and management fees for promoters.
Examinations of these arrangements may result in the following IRS actions in appropriate cases: |
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- disallow deductions for charitable contributions under Internal Revenue Code section 170 for payments to the fund;
- impose section 4966 excise taxes on sponsoring organizations and managers of donor-advised funds;
- impose section 4958 excise taxes on donors or managers of donor advised funds; and/or
- deny or revoke the charity's 501(c)(3) exemption.
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Section 4967 of the Code imposes an excise tax of 125 percent on a donor who receives more than an "incidental benefit" in connection with an advised gift made by a DAF. The notice addresses situations in which a payment from a DAF to a charity enables the donor to attend or participate in an event. It concludes that, in these situations, the donor has received a more than an incidental benefit.
In December 2017, the Treasury released Revenue Ruling 2017-73 which provided that using a DAF to satisfy the donor/advisor’s pledge to a charity is acceptable under certain circumstances: |
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- There must be no reference to the pledge in making the distribution from the donor advised fund to the charity;
- The donor/advisor must not receive more than incidental benefit; and
- The donor/advisor must not try to take a charitable deduction for the distribution from the donor advised fund to the charity, even if the charity sends the donor/advisor a written acknowledgement for the distribution. (The donor/advisor will have already received a charitable deduction for the contribution to the donor advised fund.)
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Donor-advised funds may have become even more appealing due to the Tax Cuts and Jobs Act. The new tax law raised standard deductions to $12,000 for individuals and $24,000 for married couples, which makes it more efficient for many taxpayers to simply take the standard deduction, which, eliminates the tax benefits of itemized deductions incuding charitable donations. With DAFs, taxpayers can take one large deduction in the year they set it up, even if the money doesn't get distributed right away.
Let’s not forget, at the same tine, that the TCJA raised the charitable donations limit that can be deducted in any one year. The limit is now 60% of adjusted gross income, up from 50% for gifts of cash. The tax deduction limit for gifts of stock or real property is now 30% of AGI instead of 20%. |
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| Charity donations do not seem simple anymore, not with all the options and the rules and regulations in place. Therefore it is far better to get help from a tax professional in determining all the tax deductions you are entitled to, as well as in all your dealings with the IRS. |
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