The Vialto Tax Brief
US Tax Planning—Donor Advised Funds
AUGUST 2023
For philanthropic taxpayers, a DAF can provide tax planning benefits while fulfilling their philanthropic objectives.
Taxpayers approach their tax accountants when they hear about “mysterious tax planning techniques” that may reduce their overall tax bill.
These techniques may be beneficial, but they’re easily misunderstood. One such technique available to US taxpayers is a Donor Advised Fund, or DAF. For philanthropic taxpayers, a DAF can provide tax planning benefits while fulfilling their philanthropic objectives.
A DAF operates by allowing individuals to make irrevocable contributions into a general-purpose charitable fund, generally operated by a sponsoring organization (SO), many of which are investment brokerage firms. While legal control of the contributed assets shifts to the SO, the contributing individual generally directs which qualified organization receives the funds and when the contribution will be paid. Note that only 501(c)(3) organizations are allowed to receive contributions from a charitable fund. The individual also maintains a level of control of how the funds are invested within their charitable fund—noting that each fund’s limitations may vary.
DAFs are worth considering for the following reasons:
Tax savings
Administrative ease
Wide application
Tax savings
By contributing to a DAF, a taxpayer is able to deduct the charitable contribution at the time the funds are contributed into the individual’s general-purpose charitable fund, rather than when the funds are distributed to a qualified charitable organization. If there is a particular tax year in which the taxpayer expects higher-than-average taxable income, a contribution to the DAF in that same year can maximize their charitable contribution deduction to potentially reduce their overall tax liability. Furthermore, any appreciation of the funds between the time of transfer into the DAF and time of distribution to the charitable organization grows tax free and is not subject to personal taxation.
DAFs are generally administered by investment firms, and as a result, taxpayers may be able to easily transfer long-term capital gain property (stocks, mutual funds, etc.) with large appreciated gains into the DAF. The allowable charitable deduction is the value of the stock at the date of transfer, and the taxpayer would not need to recognize the capital gain on the appreciation. The taxpayer utilizes the benefit of the stock's fair market value at the date of transfer while mitigating taxation on the gain. Note that this tax savings only applies to transfers of long-term capital gain property (i.e., property held for more than one year).
For example, a taxpayer has a brokerage account containing XYZ stock which was purchased five years ago with a cost basis of $20,000 and current fair market value of $50,000. The taxpayer contributes the XYZ stock to their newly established DAF. The taxpayer recognizes a $50,000 charitable contribution deduction on their individual income tax return. The $30,000 of long-term capital gain escapes taxation. Below is an illustration of the $9,000 additional net tax benefit of contributing the tax appreciated stock into a DAF rather than selling the stock and contributing the proceeds.
*30% is blended federal capital gains tax rate and state tax for demonstrative purposes.
**45% tax rate is blended federal, and state rate for demonstration purposes.
Administrative ease
DAFs can be set up relatively quickly and with minimal administrative cost. When compared to other charitable contribution planning methods, such as private foundations, the cost is low and the mechanics are simple. Additionally, when contributing to a DAF, only the receipts related to your fund contributions are needed, rather than individual receipts when contributing to each qualified organization.
Wide application
DAFs are not just reserved for high income earners. As a result of the state and local tax cap of $10,000, coupled with the higher standard deduction, many taxpayers no longer itemize their deductions. Contributing to a DAF is a way for taxpayers to combine their charitable contributions (or “bunch”) together in a single year to benefit from the itemized charitable deduction.
For example if a married taxpayer annually contributes $15,000 to charity A but never surpasses the standard deduction, they aren't able to recognize a tax benefit for these charitable contributions. However, if a married taxpayer with no other itemized deductions other than $10,000 of state and local income taxes “bunching” three years of contributions into a DAF ($45,000), the taxpayer would be able to itemize and realize the benefit of the charitable contribution tax deduction in the current year, in addition to the two other years’ standard deductions. Assuming the individual is in the 45% federal and state income tax bracket, that would equal approximately $13,000 in tax savings. This would be in addition to any tax savings from donating long-term capital gain property.
Several organizations offer DAFs, and individuals should consider fees, minimum funding and grant requirements, and fund investment options.
Every taxpayer's situation is different. Consult your Vialto tax advisor or one of the individuals listed below to determine what planning is available to you.
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