Individual Tax Planning Tip: Use Donor-Advised Funds to Plan Charitable Donations
As individuals look for year-end planning opportunities to see benefits on their 2019 taxes, one to keep in mind is a donor-advised fund (DAF). For those who are philanthropically minded, a DAF is an investment vehicle used to facilitate charitable donations while simultaneously minimizing tax burdens.
NOTE: DAF contributions must take place prior to year-end to apply towards 2019 tax filings.
How Does a DAF Work?
With an initial minimum contribution of at least $5,000, an individual can create a DAF — typically through an investment organization or community foundation — through which they make contributions directly. The contributions are immediately tax-deductible, however individual grants, or charitable distributions, to specific charitable organizations can be spaced out over time.
DAF contributions are typically ‘bunched’, meaning individuals will combine several years’ worth of typical charitable donations into one, giving a single sum to the DAF and then making smaller grants via the DAF over time. Individuals benefit from a bigger tax advantage by contributing a larger sum of money, yet still have the ability to make charitable distributions on a preferred schedule. And ultimately, the charity(ies) receives the same amount of donations.
DAF investments also appreciate tax-free.
Why Should I Make a Large DAF Contribution Versus Several Smaller Contributions Directly to Charities?
Historically, many charitably minded individuals leveraged itemized deductions to benefit from charitable donations. With the passage of 2017’s Tax Cuts and Jobs Act and the increase to the standard deduction, it became more difficult for individual taxpayers to itemize their deductions and effectively reduced the tax impact of charitable donations.
Bunching donations and contributing to a DAF can allow a taxpayer to itemize their deductions and see greater benefits in the frontloaded year. Subsequent years would allow for preferred distribution of the charitable funds via the DAF, while the taxpayer sees the benefit of the standard deduction.
Can I Contribute Appreciated Assets to A DAF?
Yes, in fact, this is the most impactful way to take advantage of a DAF. A direct contribution of appreciated assets (e.g. publicly traded securities, mutual funds, real estate, etc.) not only results in a tax deduction but also avoids capital gains taxes. This scenario is best applied using long-term appreciated assets — those that are held for at least one year — ensuring they can be donated at fair market value.
Scenario #1: Donor sells long-term appreciated stock & donates after-tax proceeds to charity
In this scenario, the value of the appreciated assets would be subject to capital gains taxes, therefore reducing the final amount available to donate to a given charity or charities.
Scenario #2: Donor contributes long-term appreciated stock directly to DAF
With a DAF, the appreciated assets are not subject to capital gains and therefore the full value of the assets is available to donate to a charity or charities.
Are There Other Tax Benefits to Using a DAF?
- As stated, DAF contributions are not subject to capital gains taxes.
- DAF contributions result in an immediate tax deduction based on the contribution to the DAF, not the specific grant to the organization, and investments appreciate tax-free. Cash contributions are eligible for up to a 50 percent deduction of adjusted gross income (AGI); appreciated securities are eligible for up to a 30 percent deduction of AGI.
- Investments held in a DAF are outside of an individual’s estate and thus are not subject to estate taxes.
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