No, it’s not your imagination. You are almost certainly seeing a spike in letters, emails, and calls from non-profit organizations right about now. The combination of holiday cheer and desire for year-end tax deductions makes the stretch between Thanksgiving and year end a particularly fruitful time for non-profits’ charitable giving campaigns.
For those that make charitable giving an integral part of your financial planning, you might consider utilizing a donor-advised fund (DAF) to fulfill your objectives. Being able to offset taxable income in a high income year by donating appreciated assets to a qualified charity is a primary benefit of contributing to a DAF. Simplified record-keeping and the ability to spread your gift giving over time represent other key benefits.
Donor-advised Fund…What is it?
A DAF is a charitable giving vehicle that enables you to effectively make a contribution to a qualified charity of your choice either now or in the future while retaining your eligibility to receive a tax deduction in the current year.
Essentially, financial services companies (i.e. Fidelity, Schwab, Vanguard, etc.) have set up public 501(c)(3) charities under their umbrellas and allow individually named “donor-advised” accounts to be set up within that charity. These separate charitable accounts can then receive donations from their respective owners in either cash or, more beneficially, as in-kind contributions (i.e. stocks, bonds, mutual funds, ETFs, etc.). The account owner then “advises” the fund company’s charitable arm to make a grant to a specific IRS-qualifying charity.
After the donation to the DAF, the account owner retains the ability to not only direct future grants from the account, but also direct how the funds are invested going forward so the funds can continue to grow tax free for future giving. Generally, DAF owners have a menu of mutual funds to pick from that offer conservative to more aggressive investing. Some DAF’s allow more investment flexibility for larger balances. Financial firms charge a small administrative fee on the charitable accounts for the use of their DAF platforms.
Using a donor-advised account for charitable giving can make particularly good sense when donating appreciated assets. In doing so, the donor receives a tax deduction for the market value of the securities in the year in which the assets are transferred into the account. By contributing appreciated assets instead of selling the asset first and then donating cash, the donor avoids paying capital gains tax on the appreciated asset. Since the charity is tax-exempt entity, no capital gains tax is paid and the non-profit ends up with more funds to deploy towards achieving its charitable objectives.
The following table illustrates the potential tax benefits of contributing an appreciated asset rather than selling an asset and then donating the funds.
In this example, not only will the donor get credit for tax purposes for making a $50,000 charitable contribution, but an extra $4,760 will be available to the charity than had the donor sold the stock and paid capital gains taxes.
Simplified Record Keeping
Tired of keeping track of all those checks and receipts of all the charitable gifts you make throughout the year? Your charitable contribution to the DAF is the only record you need for your tax preparation. In addition, the financial services firm offering the DAF will offer an easy-to-use interface for making your future grant requests as well as summary reports to keep track of all your donations.
Gifting Over Time
Even though you get the tax benefit now, you are under no obligation to advise the DAF to make a grant to an actual charity in the current year. This potentially allows charitable givers to offset taxable income in the current year while still preserving funds for charitable giving for future years.
Those using donor-advised funds should be aware of a few limitations. First, once the donor has passed funds or securities over to the DAF, the donor no longer has full control. The donor “advises” on what grants to make, but cannot legally bind the DAF to do so. Thus, funds from the DAF cannot be used to satisfy legally binding pledges.
Second, grants to a non-profit from a DAF must be for the sole benefit of the charity. In other words, the donor cannot receive any special perks in exchange for donation. So, receiving a special gift for a minimum sized donation or getting preferred seating at an event may not be permissible.
Not sure if a DAF is right for you? Before opening a DAF, you should carefully consider if it meets your objectives since contributions to a DAF are irrevocable. SMS Capital Management can help go over your particular situation and help determine if it’s a good fit. Furthermore, those considering a DAF should also consult their tax advisor, especially if they are contemplating using a DAF to offset a large income year.