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PERSONAL FINANCE: How to maximize the tax benefits of charitable contributions

Consider locking in this year’s charitable tax deduction with a Donor Advised Fund.

Americans are extremely generous!  According to Giving USA, Americans contributed $471 billion to charity during 2020; 69% came from individuals.  Impressive!

The easiest and least complicated way to support a charity is simply to write out a check.  A slightly more complicated means of gifting, which often has additional tax benefits, is to donate appreciated securities.  You receive a tax deduction equal to the fair market value of the security without having to recognize and pay taxes on the long-term capital gains, the appreciation since you acquired the securities. Note, though, that you may encounter some limitations if you try to claim the full value of charitable deductions during the current year; deductions will be based on how much a percentage they are of your adjusted gross income (AGI), with unused contributions allowed as carryforwards for future years.  Either form of the gift – cash or appreciated securities – requires you to donate to one or more charities.  There also are rules for contributions directly from IRA accounts.

If you don’t itemize deductions on your tax returns, charitable deductions of up to $300 ($600 on a joint return) are available to you.  And even if you don’t regularly itemize, you might do so on occasional years by making larger donations or “bunching” several small donations in the same year.

But what if you’re either undecided on which charities you want to support, or want to space your gifting over several years, but still want to reap the tax benefit in the current year?  Or what if you want to bunch your charitable deductions into a single year for the tax benefits of itemizing deductions, but want the recipient charity to receive funds consistently over time?  Then you should consider setting up a Donor Advised Fund (DAF) or a Private Foundation (PF).

Donor Advised Funds and Private Foundations are vehicles that provide for an immediate tax deduction in the year you donate cash or securities, subject again to AGI limitations, and disburse the funds in later years to the charity or charities of your choice.  That is, you capture the deduction in the current tax year and benefit the charities in later years.

I find that a DAF is preferable to a PF for most clients.  They are less expensive to set up, far easier to administrate (no bookkeeping), and less subject to IRS regulations – including minimum distribution requirements and excise taxes.  Those who chose Private Foundations over DAFs often do so for multigenerational and prestige considerations.  In certain circumstances, PFs can provide more flexibility in less common gifting situations, such as when solicited for certain types of grants.  For gifting to registered charitable organizations, I find the difference between the two to be more theoretical than operational.  With a DAF you “advise” the sponsor on your choice of charities, subject to the sponsor’s approval, which, for a tax qualified organization, I’ve yet to see denied.

We rarely consider recommending PFs unless there are multigenerational family governance considerations – often connected to family offices — and with initial funding in multi-millions of dollars.  The internet is replete with detailed comparisons of the advantages and disadvantages of both vehicles, which you should consider before setting up either one.

The beauty of setting up a DAF is its simplicity, and thus, its popularity.  A DAF can be established very quickly and at no cost. Most brokerage custodians—Fidelity, Schwab, TD Ameritrade, etc.—are sponsors and can have your DAF set up and running the same day.  Once your DAF is established, the fund sponsor handles all administrative functions. Depending on AGI limitations, the immediate tax benefits from donations to DAFs can be more favorable than from those to private foundations.

Whether your inclination for charitable giving is to simply write a check, transfer securities or set up a DAF or private foundation, maximizing the tax benefits of charitable contributions can be complicated, and should be discussed with your tax or financial advisor.

The author does not provide tax, legal, financial or investment advice. This material has been prepared for informational purposes only. You should consult your own tax, legal, financial and investment advisors before engaging in any transaction.

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