America continues to be one the most charitable countries with over $390 billion donated in 2017. This represents the fifth consecutive annual increase in giving and the largest amount ever. The vast majority of donations (72%) come from individuals with foundations making up the second largest group (15%). On top of that, Americans volunteered nearly 8 billion service hours made up of about 64.5 million individuals.
The impact of charities is rooted deep in American culture and our government has been very supportive of this by way of the U.S. tax code. While volunteer hours are not counted, most other contributions can be deducted to reduce your tax liability.
As you can imagine with most tax-related situations, charitable deductions can become very complex and are subject to various limitations, but what it also means is that there are ways to give more efficiently. While there are many different strategies when it comes to giving, this article will review donor-advised funds and their benefits. As always, feel free to reach out if you need help with any of your charitable giving questions.
Donor-Advised Funds (DAF)
A donor-advised fund is a charitable vehicle that allows an organization, family, or individual to take a deduction in the current tax year, but spread the donations out over time and to multiple charities. This is a fantastic strategy for those who are charitably inclined and who also have a spike in income from instances such as the sale of depreciated property or a business, options coming due, or even a large bonus. This will essentially allow you take your charitable deduction when you are in the highest bracket thereby offering you the greatest amount of tax savings.
Let’s say that you have options that come due and you have to recognize them as ordinary income this year. You regularly give $15,000 a year spread over multiple charities and expect to pay a marginal tax rate of 20% going forward; however, because of the options, you are in the 40% bracket this year. Instead of waiting to donate in the future when you are in a lower bracket, you could contribute multiple years of donations this year to a DAF and significantly reduce your tax liability. If you decide to contribute 5 years worth of donations this year to a DAF ($75,000), you could potentially save around $12,000 of taxes compared to spreading them out over that same time period.
To multiply this benefit even further, it is possible to donate appreciated assets and avoid having to pay any kind of capital gains. In the example above, let’s donate $75,000 worth of Apple stock that you originally paid $15,000 for into the DAF. Not only will you save $12,000 in taxes, but also an additional $12,000 of capital gains tax.
Pros and Cons
While there are obviously some major benefits to a DAF, it is also important to understand the limitations. The largest is that once the assets are put into the DAF, you are not allowed to take the money back. The assets have been given to charity now and are no longer yours. You also must give to charities and are not allowed to give to individuals for scholarships or similar benefits like a foundation can. You are not forced to give a certain percentage each year like a foundation, but the IRS does have the expectation that you will actively distribute the money over time.
Some of the additional benefits of a DAF are that the assets can actually be invested and the growth is tax-free. Grants can also be given anonymously versus foundations that require public record. There are also no startup costs and typically very little to no administration costs.
How to get started
While DAFs are not overly complex, it is important that they fit into your overall goal. As we stated previously, once you donate it is costly to go back and so it is important to get the numbers right the first time. There are also limitations to deductions and that must be accounted for as well. After consulting your planner and/or CPA on how best to utilize a DAF, it is fairly easy to open a one. Many charitable organizations have the ability to open DAFs directly. Custodians like Schwab or Fidelity have the ability to open a DAF account for you as well. If you have any questions or would like to learn more about making the most of your charitable donations, feel free to speak with one of our advisors today.
*a version of this article was first published August 17, 2015.
"Charitable Giving Statistics." National Philanthropic Trust. 2015. Retrieved from: http://www.nptrust.org/philanthropic-resources/charitable-giving-statistics/.
"Benefits." Schwab Charitable. 2015. Retrieved from: http://www.schwabcharitable.org/public/charitable/donor_advised_funds/benefits.
"Giving USA 2017: Total Charitable Donations Rise to New High of $390.05 Billion" Giving USA. June 12, 2017. https://givingusa.org/giving-usa-2017-total-charitable-donations-rise-to-new-high-of-390-05-billion/.
"The Joy of Charitable Giving: Strategies and Opportunities." Vanguard. 2015. Retrieved from: https://personal.vanguard.com/pdf/s815.pdf.