ELITE ADVISOR BEST PRACTICES
The Family Foundation of Choice - Part One
11 reasons why donor-advised funds can be an enhanced alternative to a private foundation
By Michael King
- Donor-advised funds have become the fastest-growing and most prolific charitable vehicle for individuals and families.
- The general structure and purpose of a DAF (i.e., public foundation) is similar to a private foundation, as the giver receives an immediate charitable income tax deduction and distributions or grants are then made to qualified charities over time.
- DAFs often provide affluent individuals and families with greater tax benefits, lower costs, greater privacy, more anonymity and less complexity than PFs.
When an individual or family of financial means expresses an interest in charitable giving, they are often advised to establish a PF without sufficiently considering other alternatives. In many situations, a DAF can serve as an enhanced alternative to a PF—providing greater tax benefits, lower setup costs, lower annual maintenance costs, greater privacy, opportunities for anonymous giving and significantly reduced complexity. Even when a PF is desired and appropriate, a DAF can often be used in conjunction with a PF to provide clients with greater overall benefits and flexibility.
DAFs are the most recent charitable vehicle to come on the scene. Although some form of DAFs have arguably been around since the early 1900s, it wasn’t until the early 1980s that formal DAF platforms were created. And it was not until the mid-1990s that DAFs really began to grow in popularity and availability. However, since that time, DAFs have become the fastest-growing and most prolific charitable vehicle for individuals and families. There are currently over 200,000 individual DAFs, compared to approximately 85,000 PFs. The difference in the number of DAFs versus PFs is expected to widen over the coming years, and some charitable experts believe the total number of PFs could actually decline from their current numbers as more givers, advisors and charities become aware of the benefits that DAFs provide over PFs.
The general structure and purpose of a DAF is very similar to a PF. In both cases, charitable contributions are made to the DAF or PF, the giver receives an immediate charitable income tax deduction and distributions or grants are then made to qualified charities over time. Both DAFs and PFs are often referred to as family foundations—a PF as a “private” foundation and a DAF as a “public” foundation—due to their tax status and characterization under federal tax laws. Both vehicles also provide wide flexibility in their naming. Both vehicles can be, and often are, named after the family establishing them—for example, the John and Mary Smith Foundation or the Smith Family Foundation.
The donor-advised fund as an enhanced alternative to a private foundation
The vast majority of factors and considerations involved in selecting a charitable vehicle for an individual or family weighs heavily in favor of a DAF versus a PF. Here are some of the enhanced benefits that DAFs can provide over PFs:
1. Ease of setup. A DAF can generally be established in as little as a day, and at no cost to the giver. Many DAF sponsors allow a fund to be established online in as little as five to ten minutes. A PF, on the other hand, requires the creation of a legal entity (either a corporation or a trust) and application to the IRS and state agencies for approval to receive tax-exempt status. The process for obtaining tax-exempt status will generally take at least six to nine months.
2. Greater tax deduction for cash gifts. A giver is entitled to a charitable income tax deduction of up to 50 percent of his or her adjusted gross income for cash contributions to a DAF—versus 30 percent of AGI with a PF.
3. Greater tax deduction for gifts of publicly traded stock. A giver is entitled to a charitable income tax deduction of up to 30 percent of his or her AGI for contributions of publicly traded stock to a DAF—versus 20 percent with a PF.
4. Greater tax deduction for gifts of closely held business interests and real estate. Gifts of closely held business interests and real estate that are highly appreciated can be one of the best, most tax-leveraged assets to give to charity. Contributions of these assets to a DAF are generally deductible at their fair market value. By contrast, the deduction for gifts to a PF are limited to the giver’s cost basis in the asset, thus making such assets inappropriate for giving to a PF.
The AGI deduction thresholds for closely held business interests and real estate are the same as those for publicly traded stock—30 percent of AGI for gifts to a DAF and 20 percent of AGI for gifts to a PF.
5. Greater anonymity. Grants from DAFs can be made anonymously, since distributions are made directly from the DAF sponsor—the giver does not need to be identified. Grants from PFs typically identify the PF as the source, and annual tax returns filed by the PF are required to identify all charitable organizations that received grants during the year. These PF tax returns are available for public viewing.
6. Lighter administrative burden. The DAF sponsor coordinates, and is ultimately responsible for, all administration, grant distribution, investment management and record keeping. All of the giver’s activities and involvement with his or her DAF (e.g., advice on grants, investment allocations) can generally be done online—similar to online banking. The operation of a PF vests responsibility in the giver for managing assets, balancing books, keeping records, preparing tax returns and ensuring compliance with numerous state and federal regulations.
7. Lower initial costs. Most DAFs can be established at no cost to the giver. A giver will incur various costs to establish a PF, generally involving legal, accounting and tax-related costs. These costs can easily range from $5,000 to $25,000 or more.
8. Lower ongoing costs. For givers, the cost to maintain a DAF is generally 1 percent or less of the fund balance. The ongoing costs of operating a PF can be significant and will generally include general administrative, legal, accounting and tax costs. The actual costs can vary widely depending on the size and complexity of the PF, but will generally range from a minimum of several thousand dollars to tens of thousands of dollars each year. In some cases, costs can even run into the hundreds of thousands of dollars.
9. Reduced exposure to excise taxes. PFs are subject to a number of excise taxes, including taxes on net investment income, taxes on self-dealing and taxes on the failure to distribute 5 percent of the PF assets each year. Imposition of some of these excise taxes can be confiscatory. DAFs are not subject to these specific excise taxes, though there are other excise taxes that apply to both PFs and DAFs.
10. More flexible distribution requirements. PFs are required to distribute a minimum of 5 percent of their assets each year. DAFs have no minimum distribution requirements. Particularly for those givers who want to build a sustainable endowment, the accomplishment of that goal will be much more feasible—and attained much more quickly—with a DAF.
11. Greater privacy. The public does not have access to the specific activity of an individual giver’s DAF. A PF, on the other hand, must disclose all contributions, grants and compensation paid to family members (and others) each year on its tax return filed with the IRS. The tax return is available for public inspection, and is often accessible through the Internet.
DAFs have become the fastest-growing and most prolific charitable vehicles for affluent families and individuals. But as the next installment of this article series illustrates, there are still a few potential benefits of PFs over DAFs.