Donor-advised funds, or DAFs, allow families and individuals to make tax-advantaged donations to charitable organizations. Similar to other investment accounts, a DAF allows donors to contribute assets to be donated to charitable organizations. The IRS requires such funds to be operated by 501(c)(3) organizations, or what the IRS deems “sponsoring organizations.”1
Below we’re breaking down what you need to know regarding donor-advised funds and the potential tax advantages of utilizing one.
Donor-Advised Funds Considerations
One of the most notable differences between a DAF and other investments is that the money in a DAF may not be withdrawn. Once a donation is made, it is not returnable to the donor. This requirement, and others, set up DAFs to provide significant tax advantages.
Here are a few considerations to make when looking at the advantages of a donor-advised fund.
Tax Advantage #1: Multiple Asset Types Are Accepted
Though cash donations do provide the largest deduction, donor-advised funds allow individuals to donate multiple types of assets. Some types are even difficult to liquidate but can still be accepted.
Acceptable asset types could include:
- Real estate
By no means is this an exhaustive list. It does, however, demonstrate the ability for donors to be able to diversify their donations, which in turn could potentially increase their charitable giving tax deductions.
Tax Advantage #2: Investments Grow Tax-Free
Assets that are donated to a donor-advised fund are allowed to grow tax-free. In addition, you are not required to donate those funds immediately, or even the year you made the contribution. Instead, those funds may stay-in-place and continue to grow over time. This allows you to donate a larger sum to charity while still gaining the benefit of deduction in your taxable income for the year in which the contribution was made.
Tax Advantage #3: Offset Capital Gains Tax
When an investor sells a stock that has made gains, they may be subject to paying capital gains taxes. Depending on the amount, this could account for a significant portion of the stock’s total value.
According to the IRS, this portion could be anywhere from 15 to 20 percent, and beyond, depending on asset type and income.2
If you are considering a way to offset potential capital gains tax, DAFs allow for stocks to be donated at their full value. This means that both the charity and the donor benefit. As the charity receives a larger donation, the donor receives a larger tax break.
Tax Advantage #4: Simplifies Reporting
Normally, if one were to donate to individual charities, they would need to report each charity on their taxes for the year. Utilizing a donor-advised fund can simplify the process, as donors instead report the fund’s earnings and withdrawals as a whole.
Donor-advised funds give individuals an opportunity to max out their charitable contributions. And in some situations, much of the tax savings and account growth that occurs is directly passed on to the charity of your choice. This makes DAFs an enticing strategy for charitable individuals and tax-minded investors.
The concept of a Donor-advised fund is likely not one that many of us have a lot of familiarity with. While they do hold a fair amount of complexity, the ability to achieve tax-benefits while still accomplishing charitable giving goals is significant. Many financial, tax, and legal professionals will agree that the IRS holds a special soft spot for charitable or non-profit organizations. I believe this is an area that we as investors should take full advantage of.
While it is important to pay taxes where taxes are due(Romans 13:7), let's examine this a little further from a spiritual perspective. Is it possible that our governmental bodies understand the potential of collective giving and generosity? Do they realize how powerful a united group of people are who are inclined to giving and understand the greatest needs of our communities? I would argue that, while they may not know every detail, they know that something special happens when we give to others. And they don't want to get in the way of that. In fact, they want to help. While you may or may not be in a position to gain a large tax benefit from a vehicle such as a DAF, know that there are ways to give that our government gives us greater freedom in. Let's be wise stewards of this ability and maximize it in whatever ways we can.
Evergreen Financial Group is a Fee-Only Financial Planning and Investment Firm located in Billings, MT serving clients in Montana, Wyoming and virtually across the country. Evergreen Financial Group specializes in working with Christian families, including young professionals, Current and Future Retirees and Church Staff Members.
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