A Good Time to Consider a Donor-Advised Fund

Tax Planning
For those charitably inclined, now is a good time to consider making a multi-year charitable contribution to a donor-advised fund (DAF) that can in turn be distributed over multiple years. First some background on why these are more popular and how it may work for you.

 

Background:

As a short refresher, it only makes sense to itemize deductions if your total deductions are above the standard deduction. For most people, their total deductions are from adding their state, local, and property taxes, home mortgage interest, and charitable donations. With the new tax law taking effect this year, the standard deduction has nearly doubled to $24,000 for married couples filing jointly (or $26,600 if you and your spouse are over the age of 65). Along with this increase, the ability to deduct state, local, and property taxes has been capped at $10,000. Unless you have a large mortgage and pay a significant amount of mortgage interest, you likely will not itemize this year. That is, unless you are charitably inclined.

 

Here is an example of Fred & Wilma who have paid off their home:

  • Deductions on Tax Form Schedule A for 2018
  • State, local, and property taxes: $10,000 (capped – last year they were able to deduct $38,000)
  • Home mortgage interest: $0
  • Gifts to charity 2018: $10,000
  • Total deductions: $20,000

 

Current conclusion: They will not itemize for 2018 as their total deductions are less than the $24,000 standard deduction. For Fred & Wilma to see any tax benefit from their donation, they would need to increase their charitable contribution by at least $4,000 to donate a total of $14,000 for the year to get above the standard deduction and be able to itemize.

Here is where a donor-advised fund might make sense. But first…

 

What is a Donor Advised Fund?

A DAF is a flexible and tax-efficient way to give to charity. You would set up a DAF account initially with a lump sum gift and then could gift out of your DAF account to any IRS-qualified charity at any time. The key point to understand is that your initial gift is deducted from your taxes in the year it is given (say 2018), yet you do not need to give that entire amount to charity that same year. For example, you can deposit 3 years’ worth of planned donations this year, take the deduction this year, yet give annually like you normally would over the next 3 years. However, you would be giving from your DAF account and not from your checkbook.

 

How It Works in Practice:

Using the example above, say Fred and Wilma give to The Rotary Foundation $10,000 every year. They could bunch three years’ worth of planned future contributions now. They would take the entire $30,000 charitable deduction off their taxes and itemize this year. In future years, they would take the standard deduction instead of itemizing as they couldn’t claim those year’s charitable gifts because they already applied to 2018. However, they are still able to give to Rotary from their DAF each of the next three years. The Rotary received their pledged donations as usual with no interruptions.

 

Deductions on Tax Form Schedule A for 2018

  • State, local, and property taxes: $10,000 (capped – last year they were able to deduct $38,000)
  • Home mortgage interest: $0
  • Gifts to charity 2018: $30,000
  • Total deductions: $40,000

 

Result: They will itemize for 2018 as their total deductions are greater than the $24,000 standard deduction. In 2019, they will only have total deductions of $10,000 from state, local, and property taxes because they ‘accelerated’ their charitable gift (from a tax perspective) in 2018. Therefore, they will take the standard deduction in 2019.

 

Additional Helpful Tidbits:

  1. Making any charitable gift in the form of securities instead of cash is advantageous because it allows you to avoid recognizing capital gains taxes. You can do the same thing with a Donor-Advised Fund. Donate to it shares of stock (or other investments) with a low-cost basis. You are able to recognize the current market value of the holding at the time of gifting on your tax return and avoid paying the capital gains tax.
  2. If you have already made your 2018 charitable gifts, set a DAF up this year for planned giving in 2019, 2020, and beyond so that you’ll get to deduct even more off your taxes.
  3. You can invest the DAF account in the stock market. All the investment growth just means you can direct more money to the charities that you support. There are no annual required distributions from a DAF like there are with a private foundation.
  4. One thing that I believe intimidates families when setting up a DAF is concerns on ease of use. Many of our clients have a DAF set up at Schwab. They have all commented on how easy it is to look up charities and make gifts. You can even set up an automatic payment from your DAF so that you can avoid writing weekly checks to your church, for example.

 

Lots of information here. We are happy to discuss whether a DAF could make sense for your situation so that you can review the concept with your tax professional. Please call or email if you have any questions.

About the Author: Alex Perkins

Alex is a Wealth Advisor for WealthPoint Advisors, LLC. After a successful career in management consulting where he helped business executives solve their corporate challenges, he decided to pursue a passion in helping families and individuals on the personal side. Alex now enjoys helping his clients answer their most pressing financial and life questions, through a comprehensive, evidence-based wealth management approach.