I always cringe when I hear people tell me they give cash to a charity instead of stock. Don't get me wrong, gifting to a charity is a noble cause, but there are better ways to gift then writing a check. Gifting low basis stock, restricted stock, or other highly appreciated property generally comes with better income tax advantages - namely not paying the capital gains tax on the appreciated asset.
A Donor Advised Fund is an excellent tool to help facilitate the transfer of stock to a charity. Executives with low basis company stock or investors who have gains in a stock they don't want to sell and incur the capital gains tax can use a donor-advised fund (DAF) to gift the shares to a charity and receive an immediate income tax deduction in the year they make the gift. However, once the money is in the DAF, the account owner can take his or her time in deciding which specific charities to receive the gift or gifts. If this sounds strange, you are correct, the rules of a DAF are different than traditional charitable gifts. Here's how it works:
Donor-Advised Fund Basics
A DAF allows people to give a portion of their money, assets, or property to charity in order to receive a tax deduction immediately. However, the holder isn't required to decide on their preferred charity at the time of donation. Instead, the account holder can gift out money from their DAF to charities as they see fit - giving some money this year and some next year for example.
DAFs are great for organizing your charitable giving. Instead of holding onto cashed checks or keeping records, the DAF summarizes all transactions - money in and money out - in one simple report. This makes it easy come tax time.
This diagram is from the Climate Trust Donor Advised Fund
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 invest with. Each one will have their own fees and restrictions for holding onto the funds. This is where a financial advisor can help, advising you on what to look for. Account holders can then gift their assets into the DAF. This can be anything from cash to private stocks to real estate to bonds. As long as the assets aren't publicly traded, you are eligible for the tax deduction as soon as the assets are promised to an approved charitable organization. The funds inside this account are entirely tax-free, which means they can grow without incurring taxes.
How to Use a Donor-Advised Fund
Money in a DAF can be invested in a suite of mutual funds like a 401(k). Some people will use a DAF in lieu of setting up some type of trust for a particular organization while others will front-load their account to give themselves enough time to grow their charitable assets. Typically, individuals will set up a DAF during a high-income year in order to avoid paying full taxes on their income while still being able to support a noble cause. Any charity that has been approved by the IRS is eligible to benefit from a DAF.
The best use of a Donor Advised Fund is in really high income years - when I have a client with large capital gains or if he or she sold some company stock. In those years, I encourage the client to try bunching the next few years of their charitable contributions in the current year by making a large gift to the DAF. They receive an immediate tax deduction in that year, but can doll the money out to charities over time. -Michael Aloi
Donor Advised Funds vs. Private Foundations
Many choose DAFs over private foundations for their simplicity, ease of setting up, and lower administrative costs. Private foundations can be used for greater customization and have the ability to pay the children to serve on the board. Donor Advised Funds are private, whereas gifts from a Foundation are public information. There are many other advantages and disadvantages when comparing DAFs to Family Foundations, including the tax deduction for foundations is lower than DAFs, so it is best to speak to a qualified professional beforehand.
How Executives Can Use Donor Advised Funds
Executive looking to divest of their company stock but don't want to incur the capital gains tax on the sale can gift their company stock directly to the Donor Advised Fund. This way he or she can unload the stock, receive an income tax deduction, and complete the gift to a charity. Executives may also be able to gift restricted stock, depending on their company plan. Donating restricted stock to charity or a donor-advised fund account is generally deductible, for those who itemize, at fair market value on the date of contribution. Rule 144 or control persons may have to get approval from their company's general counsel.
Donor-Advised Fund Tax Information
Any contributions made to a DAF are classified as a 501(c)(3) gift. The IRS allows the individual to give up to 50% of their Adjusted Gross Income in cash and up to 30% in other types of assets.1 Liquid gifts such as cash are taken at market value, but illiquid investments will need to be evaluated by an independent appraiser for the exact monetary value. Individuals who want to exercise specific investment strategies will need to check with the organization managing their account. Each one will have their own list of approved means of growing the funds.
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 as well as their own investment portfolio.
If you need help evaluating whether a Donor Advised Fund makes sense, schedule time with me for a complimentary review.
This content is developed from sources believed to be providing accurate information, and provided by Twenty Over Ten. It may not be used for the purpose of avoiding any federal tax penalties. Please consult legal or tax professionals for specific information regarding your individual situation. The opinions expressed and material provided are for general information, and should not be considered a solicitation for the purchase or sale of any security.