Donor Advised Funds promise a convenient way to benefit your favorite charities and obtain tax deductions, but they do have some disadvantages. This video explains Donor Advised Funds and then compares them with their close competitors, Private Foundations.
A Donor Advised Fund or DAF is an investment account maintained by a Charitable Sponsor or Sponsoring Organization. Donors contribute assets to the account and receive immediate tax deductions. The Donor asks the Sponsor to distribute funds or grants to IRS-qualified charities. Then the Sponsor reviews the Donor’s recommendation and distributes grants to those charities.
To understand how a Donor Advised Fund works, we must know more about the roles of the Donor, the Sponsor, and the charitable beneficiaries.
The Donor
The Donor can contribute various assets to a Donor Advised Fund, including cash, stock, real estate, art, cryptocurrencies, and some types of business interests.
Upon making the charitable contribution, the Donor receives an immediate tax deduction. For cash contributions, the Donor may receive an income tax deduction of up to 60% of the donor’s Adjusted Gross Income or AGI. For long-term appreciated assets, the Donor may receive a deduction up to 30% of the donor’s AGI, based on the fair market value of the assets contributed. The Donor may also avoid capital gains tax by donating appreciated property to the DAF.
The Donor retains “Advisory Rights” to recommend distributions from the DAF to 501(c)(3) charities.
The Sponsors
Several different categories of Sponsors offer DAFs. Some are commercial DAFS, that is, the charitable arms of financial institutions like Fidelity Charitable, Vanguard Charitable, and Schwab Charitable. Others are community foundations serving defined geographic regions, such as the California Community Foundation, the Greater Miami Jewish Federation, and the Communities Foundation of Texas. Some nationwide faith-based Sponsors also offer DAFs, including the National Christian Foundation, the Jewish National Fund, and the Knights of Columbus Charitable Fund.
DAFs are themselves 501(c)(3) charitable organizations.
The Sponsor invests the funds donated to the DAF, sometimes allowing the donor to choose from a limited set of investment options. Many Sponsors require a minimum contribution to establish a DAF account. Five-thousand dollars is a typical required minimum. The Sponsor disburses grants to 501(c)(3) organizations upon the Donors’ recommendations. The Sponsor administers the DAF and files the required tax returns, so the Donor does not incur any direct administrative costs or headaches.
Sponsors receive a fee for managing the DAF, which typically is a percentage of the funds under management. Some Sponsors also receive commissions for selling and trading assets. For this reason, advisors working for financial institutions may have financial incentives to guide their clients to DAFs as opposed to private foundations.
The Charities
The recipients of distributions from DAFs must be IRS-qualified public charities – that is, public charities with 501(c)(3) status. Note that DAFs are for donations to be given to multiple charities. Donors who wish to benefit only one charity can make their donations directly to the charity or may establish other types of funds, which may be called, for example, Agency Funds or Designated Funds.
The process for making grants is straightforward. The Donor recommends a grant, the Sponsor reviews the recommendation to be sure it complies with the rules and regulations governing DAFs, and then the Sponsor distributes the grant funds to the charity.
The DAF Agreement
Each Sponsor’s DAF differs in the details, which are set forth in the DAF Agreement.
While the Donor is alive and has capacity, the Donor retains advisory rights to recommend, but not direct, grants to 501(c)(3) charitable organizations. The DAF Agreement does not appear to be a legally enforceable contract; the Donor only right under the Agreement is to request or recommend certain charitable donations.
What happens when the Donor becomes incapacitated or dies? The DAF Agreement determines what happens and whether the Donor can appoint successor advisors to recommend charitable donations. Under some DAF Agreements, the Sponsor completely controls the DAF funds when the Donor becomes incapacitated or dies. Some Sponsors are more flexible in modifying their DAF Agreements to allow Donors to plan for their succession.
As an estate planning attorney, I highly recommend that, if you fund a DAF, you shop around and have an attorney review the agreement before you sign it.
Donor Advised Funds vs. Private Foundations
Donor Advised Funds are often recommended as a simpler alternative to a Charitable Foundation or Private Foundation. For more details on Private Foundations, see my post on that topic. Now, let’s briefly compare DAFs to Charitable Foundations.
DAFs are often recommended for their administrative ease and cost. The DAF Sponsor takes care of everything after assets are donated to a DAF, while the Donor and the Donor’s family or business are responsible for all administration and costs of a Private Foundation. A Donor can start a DAF account with a relatively small amount of money.
DAFs offer more tax flexibility. For example, taxpayers who Donate appreciated assets to DAFs can deduct them at their fair market value. By contrast, taxpayers can deduct only the cost basis of appreciated assets donated to Private Foundations. While assets in a DAF grow tax-free, Private Foundations are subject to an excise tax.
The Donor of a DAF retains only “advisory rights” or the ability to recommend distributions, while the Donor of a Private Foundation can maintain total control over a Private Foundation. The Donor of a DAF can remain anonymous, while a Private Foundation is a matter of public record. Unlike a DAF, the Donor of a Private Foundation and the Donor’s family can work for the Donor’s Private Foundation. Finally, a Donor may or may not be able to appoint successors to the Donor’s advisory rights with a DAF, depending on the DAF Agreement. By contrast, the Donor of a Private Foundation can determine exactly how the Private Foundation is controlled when the Donor becomes incapacitated or passes.
I’m Daniel Van Slyke, attorney at law. As you can see, charitable planning – including choosing between a DAF or a Private Foundation – can be complex. Contact me to discuss your options for charitable giving.