We all have our favorite charitable causes that pull at our heartstrings, move us to action, and motivate us to donate money. Whether it’s volunteering our time, attending events that benefit our charity, or writing a check periodically, we feel an incredible sense of happiness and fulfillment in making a difference in the lives of others. When it comes to giving, many families generously write a check from their personal checking account and then give the receipt to their CPA come tax time. According to Giving USA, in 2017 some $410 billion dollars in gifts were donated, with 86.6% of those gifts given by cash or check. Most of these donors never stopped to question, “What if there is a more effective way for me to give?”
Private Foundations
For ultra-high net worth families, the go-to plan for charitable giving has been through the private foundation. While these entities have been around for a long time, the current framework came out of the Tax Reform Act of 1969. Two of the largest and most well-known private foundations include the Bill and Melinda Gates Foundation and the Ford Foundation, with assets totaling $44 billion and $12 billion respectively1. These entities are legally established, non-profit, charitable organizations created and funded by a single individual, a family, or a business. The funds in a private foundation are managed by either a trustee or a board of directors, who oversees the management of the assets and gives grants to deserving causes that align with the foundation’s mission. For these well-to-do families, once the foundation has been established, their adult children are oftentimes given a salaried role on the board of directors.
Traditionally, the private foundation has been a great way for a family to make donations, involve their children in philanthropy, and, of course, take a significant income tax deduction. The process and costs for establishing these types of foundations, as well as the ongoing reporting requirements, can be substantial, which is why they have been used primarily by the ultra-wealthy. In addition, there are IRS rules which require annual distributions to qualifying charities of at least 5% of the foundation's assets, otherwise they face a stiff 30% excise tax on the amount that should have been distributed.
Donor Advised Funds
For the rest of us, there is an alternative to the private foundation: Donor Advised Funds. The first Donor Advised Funds (DAF) were established in the 1930s, with the legal framework clarified in 1969. A DAF is a philanthropic, charitable giving vehicle that can be funded with either cash or appreciated securities. An immediate current year income tax deduction is received by the donor for the amount donated, while grants to charities from the DAF can be made later, even years in the future. The assets inside the DAF are invested according to the goals of the donor and grow, tax-free. Additionally, there are no mandatory annual distribution requirements.
DAFs are much easier and cheaper to establish than private foundations. In fact, institutions like Vanguard Charitable ($25,000 minimum investment) and Schwab Charitable ($5,000 minimum investment) offer DAFs with low annual administration expenses (0.60% per year on the first $500k for both) plus the underlying expenses of the funds invested in. When it’s time to make a donation, a form is completed online to make a recommendation for the fund to distribute cash to the favorite tax-exempt Section 501(c)(3) organization and the rest is done by the DAF provider.
If chosen, gifts can even be made anonymously, and it’s easy to involve the whole family in the process. Prior to establishing a DAF, many grantors sit down with the family, explain the purpose of the fund, and create the fund’s mission statement. Together, the family can decide which organizations will benefit from the fund, both immediately and in the future. Additional contributions can be made at any time, and with proper management, this family fund could continue in perpetuity for generations to come.
Front-Load Your Gifts
Under current tax law, one must itemize deductions on the federal tax return in order to receive an income tax deduction from charitable donations. In 2018, the standard deduction for single filers is $12,000 and for married couples is $24,000. With the elimination of the deductibility of state income taxes and property taxes above $10,000 on one’s federal tax return, more people will likely be using the standard deduction. For example, what if a married couple with mortgage deductions, charitable donations, and state and local taxes finds themselves under the $24,000 cap for the standard deduction, but they have high current income? It could make sense in this high-income year to make a larger than normal contribution to a Donor Advised Fund in order to itemize their deductions. If this couple normally gives $10,000 per year to their favorite causes, this year they could donate $50,000 to their DAF. They’d then receive a current year income tax deduction (up to 60% of Adjusted Gross Income) along with their other itemized deductions. Contributions are then invested inside the fund while the donors reserve the right to decide when to make the grants through the DAF. Perhaps they continue to give $10,000 per year over the next five years from the fund, but they would benefit from the full income tax deduction today, plus retain the opportunity to grow the fund through investment performance during those five years.
Gifting Appreciated Assets to Your Donor Advised Fund
Another way to maximize charitable gifts is by donating highly appreciated assets from a taxable investment account to a DAF. This can be especially advantageous in the current economic environment. As of August 22nd, we officially find ourselves in the longest bull market in history for US Stocks2 and thus most accounts likely have significant long-term capital gains. Suppose a married couple has $50,000 this year to donate to a charity, but they simultaneously have an account with highly appreciated securities. The couple could then donate $50,000 of appreciated stocks, mutual funds, or ETFs to a Donor Advised Fund instead of cash. They would receive a current year income tax deduction on the transfer of the assets (limited to 30% of Adjusted Gross Income this time). These assets are then sold inside the DAF with no tax consequences and reallocated to a model investment portfolio designed to match the fund’s goals. The $50,000 of cash that would have been donated is then used to buy back those same shares of stocks, mutual funds, or ETFs in the taxable investment account, thus increasing the cost basis of these investments with the new cash. Yes, everyone wins here except the government.
Qualified Charitable Distribution
A Qualified Charitable Distribution (QCD) is the distribution of funds from an Individual Retirement Account paid directly to a qualified charity. Eager to begin receiving tax revenue from all those pre-tax and tax-deferred IRA contributions, the government requires a minimum distribution (RMDs) from an individual’s retirement account each year upon turning age 70 ½. That withdrawal is treated as current year taxable income. By using a QCD, one could make a donation (up to a maximum of $100,000 per person/per year) directly to the charity while the amount donated offsets the required minimum distribution. Consider the fact that many high net worth individuals in the RMD stage find they are receiving more in required distributions than they actually want or need. Essentially, they are paying taxes on an income they do not yet need or use. By making the charitable contribution directly from the IRA, their required distribution and taxes are reduced when using the QCD method. This is especially important for those unable to itemize their deductions, as now their charitable contributions can be taken in full. If you are currently taking RMDs and making charitable contributions, QCD’s deserve your attention.
The bottom line? You don’t have to be Bill Gates or Warren Buffet to effectively donate to charities and improve the world. These are a few options to consider with your financial advisor and CPA to potentially maximize the power of your generosity. Imagine how great it would feel to make a large charitable contribution, receive a current year income tax deduction, AND do it all very efficiently.
Happy Planning,
Brian
1: National Philanthropic Trust – “25 Largest US Foundations by Total Assets, 2017”
2: CNBC - "3,453 days later, the US bull market becomes the longest on record"