Regaling the Donor Advised Fund – The Swiss Army Knife of Charitable Giving

By Steven Smith | Peak Thoughts

Nov 06

Nothing sharpens the mind like a deadline. Sometime around Halloween, when we have a couple of months left in the year, we begin to think in earnest about our charitable giving. On account of the charitable contribution deduction on Schedule A of the 1040 individual income tax return, many taxpayers scramble to complete their charitable contributions by year-end to include them on this year’s return. But things have changed under the 2017 Tax Cuts and Jobs Act (TCJA).

The new law, which went into effect on January 1, 2018, introduced three significant changes affecting charitable giving: eliminating personal exemptions, limiting many previously allowed itemized deductions and raising the standard deduction.

It is anticipated that households claiming itemized deductions will be reduced from 37 million to 16 million in 2018. And many of these taxpayers will be taken by surprise when they learn – in April of 2019 – that they won’t be able to itemize on their 2018 returns.

But there are some compelling workarounds. The venerable Donor Advised Fund (DAF) is one of the best.

Taxes, Taxes, Taxes

A multitude of factors motivates charitable giving. Social, emotional, political and of course religious. Nevertheless, the tax code has provided an economic incentive for philanthropy by including a deduction for charitable contributions for over 100 years. But today the deduction is only available to taxpayers who decline the standard deduction and itemize their deductions on Schedule A.

While tax rates have been lowered across the board; whether any individual taxpayer will ultimately have a smaller tax bill will also depend on the amount of taxable income. Which will in turn depend on how their deductions may have changed under the new law. Understandably, many non-profits are concerned that this new tax law is going to reduce the level of contributions at a time when the needs of their constituents continue to escalate.

Under prior law, all taxpayers were entitled to a personal exemption of $4,050 for themselves, their spouse and each dependent. The TCJA eliminated the personal exemption – even for taxpayers who itemize – and rolled that benefit into the standard deduction, which has been raised from $12,700 to $24,000 for married taxpayers filing jointly.

Whether or not you can itemize on Schedule A requires comparing your potential itemized deductions to the new standard deduction. Potential itemized deductions (e.g., state and local taxes, mortgage interest, medical expenses in excess of 10% of Adjusted Gross Income (AGI), and charitable contributions) are all added together; and if they exceed the standard deduction, you can itemize and lower your tax bill.

For example, in 2017, a couple might have had AGI between $100,000 and $200,000, $8,100 in personal exemptions and the following deductions: $10,000 in mortgage interest, $10,000 in state income and property taxes and $4,000 in charitable contributions; bringing their total exemptions/deductions to $32,100. (The new law caps state and local income and property tax deductions (SALT) at a combined $10,000 – not nearly as big a problem in a moderate tax state like Colorado as it will be in New York and California.) But in 2018, because of the standard deduction having been increased to $24,000, the same couple would have no incentive to itemize and would lose any tax benefit from the $4,000 in charitable contributions.

Thanks a Bunch – Enter the Donor Advised Fund

A few names have emerged for a strategy to work around the effect of the increase in the standard deduction and elimination of personal exemptions. Grouping, lumping, front loading and my favorite – bunching. Under this strategy, you advance several years’ worth of charitable contributions into one year – and take the full amount as an itemized deduction on Schedule A. Then revert to the standard deduction in later years. This is an especially good strategy when you might be moving from a higher tax bracket to a lower one in subsequent years, for example in planning to retire. A DAF – which acts like a staging area for your charitable contributions, enabling distributions at your own pace to their ultimate non-profit destinations – is the perfect tool to take advantage of this strategy.

Donor Advised Funds, which must be sponsored by a public charity, have been around since the 1930’s. But have gained popularity in the last twenty-five years. According to the National Philanthropic Trust, as of 2016 there were 285,000 individual DAF’s in the US, owning $85 billion in total assets. In 2016 donors contributed $23 billion to their funds and recommended almost $16 billion in distributions to qualified charities,

In some circles, the DAF has taken a few punches lately. But, except in a few very rare cases, none have landed particularly hard. While it’s true that some extremely wealthy donors are abusing this well-worn charitable device, for many donors and most charities the DAF is an excellent vehicle for managing individual and family philanthropy.

The Kids are Alright

One of the great attributes of a DAF is its ability to engender a tradition of family giving. According to a report recently released by Fidelity Charitable, people who give to charity as children are more likely to become happy adults. And are more likely to have close family ties. Family philanthropy also instills a sense of financial responsibility among younger generations and is one of the best ways to pass along a family’s values to successive generations.

Pocketing Your Profits

A DAF can be the recipient of donations of appreciated securities, real estate or even an interest in a privately held business. Following a ten-year bull market, this is another great way to obtain an additional tax benefit for a charitable contribution. You get a deduction for the entirety of the fair market value of the gift and neither you nor the charity recognize capital gain when the asset is sold by the charity; eliminating the previously unrealized capital gain forever. This might also be a good way to unwind concentrated risk in an individual stock position while rebalancing and/or diversifying a portfolio.

Choosing Your DAF and Your Investments

As mentioned, the umbrella organization for a DAF must be a public charity. Among the more common sponsors of DAF’s are your local community foundation. (Full disclosure; I serve on the Board of Trustees of the Summit Foundation, which sponsors a DAF.) DAF’s are also sponsored by all three of the large discount investment companies: Schwab, Vanguard and Fidelity. And there are certain specialized charities and non-profit organizations which also sponsor them. Fees vary among sponsors. As do the limitations and levels of support.

The various DAF choices may have both significant and subtle distinctions between them:

  • Minimums – both for contributions and distribution amounts.
  • Fees – they vary.
  • Support – some leave you more or less on your own. Others provide significant guidance on managing your fund and choosing the recipients of your distributions.
  • Acceptable Assets – review these policies carefully. Especially if you want to donate a unique asset.
  • Succession and Liquidation Policies – vary significantly from organization to organization. Look carefully and make sure you appoint a successor if you want your children and grandchildren to carry on your philanthropic legacy.
  • Investments – Many DAF’s offer a number of investment choices. From very safe cash or cash like asset classes to a global all-stock portfolio. A good idea is to keep a year or two’s worth of projected giving in the low-risk choice while taking more risk in the longer-term portion to hopefully allow for greater giving in future years. Some DAF’s have a limited lineup of investment choices. Others offer a virtually unlimited open architecture, allowing you or your advisor to customize a portfolio consistent with your own investment philosophy and acumen.

So much for the DAF, next week we will explore another useful philanthropic device – the IRA Charitable Rollover.

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