A donor-advised fund (DAF) allows individuals to support their favorite charitable causes in a potentially more convenient and tax-efficient way. However, the rules for DAFs differ from those for traditional charitable gifts. The donor is allowed to set aside their funds in a separate account to be later distributed to charities, which can be in a future year. When they set aside this money, they can take a tax deduction for the amount set aside.  

Donor-Advised Fund Basics

A DAF allows people to donate money, assets, or property to a charitable fund and to receive a full tax deduction immediately. However, the donor isn’t required to decide on their preferred charity at the time of donation. Instead, the fund is administered by a nonprofit institution or an eligible charitable organization so the IRS can be assured that the money is not being mismanaged. This organization will typically charge a fee to administer the fund. Fidelity Charitable is one institution where you can establish a DAF. 

How to Use a Donor-Advised Fund

When the assets are in the DAF, the individual donor has the option to grant the funds right away or invest them in the account to give away later. Some people will use a DAF in lieu of donating directly to a charity each year or setting up a private foundation with more costs and regulations. Any charity approved by the IRS is potentially eligible for a grant from a DAF. 

Grants to charities don’t have to take place every year, but there needs to be an ongoing giving strategy for the DAF to retain its tax-exempt status. As an example, Fidelity Charitable requires donors to recommend at least one grant every two years. Many people donate a large sum to their DAF and then use the DAF to make their annual charitable contributions for the next 2-10 years or beyond. 

How to Donate to a Donor-Advised Fund

If you choose to open a DAF, the first step is to choose which organization you want to manage the fund. Each one will have their own fees and restrictions for holding onto the money. DAFs are flexible in the sense that you can donate cash, stocks, bonds, or mutual funds, just to name a few. Once donated, the funds inside this account are entirely tax-free, which means they can be sold and reinvested to grow without additional tax to you.  

Using Your Discretion

Charities evolve throughout the year, changing strategies, leadership, and even their focus. If you no longer wish to support a particular charity, you are not required to donate to them from the DAF even if you have made gifts in the past. Using Fidelity Charitable as an example, as long as the charity is listed in their database, you can make a grant to them. 

Donor-Advised Fund Tax Information

Any contributions made to a DAF are classified as a tax-deductible gift. The IRS allows individuals to give up to 60% of their adjusted gross income in cash and up to 30% in other types of assets. Gifts such as cash, bonds, stocks, ETFs, or mutual funds are valued at fair market value on the day of donation, but illiquid investments will need to be evaluated by an independent appraiser to determine their exact monetary value. However, any income generated by the investments or gains from sales will not be taxable to you since those assets have already been given away.  

Please note that if you plan to donate shares of your privately held corporate stock, you should first consult professional advisors. The main reason for this is because many shareholder agreements include a provision that the stock must be sold if ownership is transferred outside of certain owners or employees. For the IRS, that means that transactions should be treated as a taxable redemption where the cash is then donated to the DAF. In a recent court case, the tax court allowed a donation of privately held stock because the taxpayer complied with specific rules.  

Another charitable giving strategy, qualified charitable donations (QCDs), involves transferring a certain amount from your IRA to a charity. A DAF is not a qualified charity for this purpose.  

It is important to note that you may not receive a tax document for your contributions to a DAF. You need to keep a record of what was donated and provide it to your tax preparer.  

Tax Strategies

Your largest lifetime expense is likely income taxes. A DAF can be a powerful tool in your lifetime tax reduction toolbox if you are charitably inclined. You can donate highly appreciated securities such as stocks, ETFs, or mutual funds to a DAF and completely avoid any capital gain taxes on the sale. In addition, you can take a charitable deduction for the fair market value of the assets on the date of donation. 

It may make sense to “bunch” your charitable contributions into one year and make none the next. This will allow you to potentially itemize your deductions in one year and then take the standard deduction in the next.  

Although there is a lot to consider when evaluating a donor-advised fund, you don’t have to do it alone. If you need assistance with your tax planning or retirement planning in general, please reach out to our team. You can read more about giving strategies such as making tax-efficient gifts to individuals and making tax-efficient gifts to charity on our website.