A donor-advised fund (DAF) gives individuals a chance to support their favorite charitable causes in a potentially more convenient and tax efficient way. However, the rules of a DAF are different compared to traditional charitable gifts. It allows the donor to set aside their funds in a tax deductible account before distributing to charities.
Donor-Advised Fund Basics
A DAF allows people to donate money, assets, or property to a charitable fund (DAF) 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.
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 that has been approved by the IRS is potentially eligible to receive a grant from a DAF.
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. Donor-advised funds 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 grow without additional tax to you.
Using Your Discretion
Charities evolve throughout the year, changing strategies, leadership, and even their focus. Those who donate to a DAF can observe these changes as a means of controlling which causes to support. 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.
Donor-Advised Fund Tax Information
Any contributions made to a DAF are classified as a tax-deductible gift. The IRS allows the individual to give up to 60% of their Adjusted Gross Income in cash and up to 30% in other types of assets.1 Liquid gifts such as cash or stock are taken at market value on the day of donation, but illiquid investments will need to be evaluated by an independent appraiser for the 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 gifted away. A word of caution however, is that currently the IRS does not allow Qualified Charitable Distributions (transfers from your IRA) to be made to a donor-advised fund.
There are tax strategies that can be implemented with the use of a DAF. For clients who are charitably inclined it may make sense to "bunch" your charitable contributions. What this means is that you would make "extra" charitable contributions one year, and none the next. What this will do is allow you to increase your charitable itemized deductions in one year, then take the standard deduction in the next. In addition to that, you can donate appreciated securities, such as stock or mutual funds, and avoid any capital gains tax while still being able to take the full charitable deduction.
There is a lot to consider when it comes to getting the most out of DAF. However, it may be a good choice for individuals who want to maximize their charitable donations.