Donor-Advised Funds (DAFs)
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TL;DR A donor-advised fund (DAF) is an investment account, created for the sole purpose of supporting charitable organizations. A donor-advised fund allows you to give appreciated stock or assets like crypto to charity and receive an immediate tax deduction in a high-income year, with the flexibility to determine which charities you want to give to at a later time. Donor-advised funds can also be an effective way to bring your family together and talk to your kids about their giving strategies.
A donor-advised fund (DAF) is a charitable giving vehicle where a public charity administrator manages donations on behalf of individual donors. A donor-advised fund can be thought of as a separate account held with the administrating charity in the name of the donor. A donor-advised fund is basically an intermediary holding vehicle for charitable contributions. The donated funds count as a tax deduction for the donor in the current year (and are no longer included in the donor’s taxable estate). Notably, the donor does not yet need to direct the funds to an operating charity. The donor will ultimately distribute the funds out of the donor-advised fund to operating charities, but this can occur over many years. Unlike private foundations, donor-advised funds do not have a legally mandated minimum payout requirement.
If you have a lot of income in one year that you would like to offset with charitable deductions, but you aren’t sure who you want to give the money to, a donor-advised fund can be a very effective planning tool for you.
As an example of a strong use case for a donor-advised fund:
- In the year following your company’s IPO, you exercise options, sell shares, and otherwise create a sizable taxable income for the year.
- Given your liquidity event, you’ve decided you want to fund some charitable contributions.
- You create a donor-advised fund and transfer long-term, highly appreciated stock to it.
- The donor-advised fund might then sell the stock and reinvest into a diversified portfolio, or it could hold the transferred position.
- When you are ready to make a gift to a specific charity over the next few years, you simply instruct the donor-advised fund to do so.
- The donor-advised fund sells shares if needed, and it sends cash to the recipient charity.
By front-loading many years of charitable giving, you can offset years of unusually high income, thereby avoiding a high marginal tax rate in that year. The large donation to the donor-advised fund qualifies as an itemized deduction against your gross income. Since your gross income is so high from the liquidity event, you may be in the highest marginal bracket or at least higher than your typical bracket. Thus, getting the deduction against the high marginal rate is particularly valuable in the year you have a spike in taxable income.
Outside of those with big one-year income spikes, donor-advised funds can also be particularly helpful if you plan to give a small amount to many charities. Because you are making small gifts, donating stock in-kind may not be possible. If you donate cash directly, you miss out on the capital gains tax saving opportunity. While for each individual transaction, the difference may be small, across many transactions the missed tax savings can become significant. By using a donor-advised fund, you can capture the tax savings and still make small cash contributions to your desired charities.
Donating Appreciated Stock: A Case Study
By donating appreciated stock held for more than one year directly to a DAF—rather than liquidating it and then donating the proceeds—you can reduce your tax liability by eliminating capital gains tax (20%), and reduce your marginal income tax.
For example, a donor has $100,000 in long-term appreciated stock, and its original cost-basis was $10,000:
Using a DAF, this donor would have more available to give to charity and would pay less in taxes. This strategy can often allow donors to give more than 20% more to the causes they care about.
NOTE: For the purposes of illustration, this hypothetical example assumes a 35% income tax rate. It also assumes that all realized gains are subject to the federal long-term capital gains rate of 20% and the Medicare surtax of 3.8%. No other state taxes are taken into account.
Some important things to note:
- You can fund a donor-advised fund with cash, but highly appreciated assets are the preferred funding choice because of the extra tax benefits.
- Donor-advised funds are not required to provide the public with their donor listing, which also allows donors to make anonymous gifts.
- Donor-advised funds allow donations of appreciated crypto and private stock that normal charities might otherwise not accept. If you give private stock directly to a foundation, you can only deduct your cost basis, not the fair market value, so giving through a donor-advised fund allows for a larger tax deduction. (Gifting private stock and crypto worth over $5k will require an independent appraisal to determine the value of the gift.)
Lastly, donor-advised funds can provide an important opportunity to build your family's culture. You can include your children when you are making decisions about where to recommend grants from your fund. The actual work or making donations will all be done by the fund provider. That means you can focus instead on instilling the principles of charitable giving in your kids, and enjoy collaborating with your family on how you can make an impact with your giving.