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, Americans donated $499.33 billion dollars to charity in 2022. Individuals continue to comprise the largest source of total charitable giving in the United States, making up 64 percent of all donations.
The majority of those gifts were made with cash, checks, or credit cards.
What if there is a more effective way to give?
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 $69 billion and $16 billion respectively.2
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 oversee the management of the assets and give 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 that 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.
According to The National Philanthropic Trust, there were 1,285,802 donor advised fund accounts holding $234.06 billion in assets in 2021.3
DAFs are much easier and cheaper to establish than private foundations. In fact, institutions like Vanguard Charitable ($25,000 minimum investment to open an account) and Schwab Charitable (no minimum investment for a core account) 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, the donor completes a form making a recommendation for the fund to distribute cash to a tax-exempt Section 501(c)(3) organization, and the rest is done by the DAF provider.
Gifts can even be made anonymously if preferred, 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 their federal tax return in order to receive an income tax deduction from charitable donations.
In 2023, the standard deduction for single filers is $13,850, and for married couples is $27,700.
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 $27,700 cap for the standard deduction, but have high current income?
In this high-income year, they can 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, but now they make grants from the fund. And they would benefit from receiving 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 to those who have been investing over a long period of time and have substantial capital gains.
Suppose a married couple has $50,000 this year to donate to a charity, and they also have a taxable account with highly appreciated securities. The couple could then donate $50,000 of appreciated stocks, mutual funds, or exchange traded funds (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 married couple then takes the $50,000 of cash that would have been donated and contributes it back into the original taxable account, where they repurchase those same shares of stocks, mutual funds, or ETFs in the taxable investment account. This purchase increases the cost basis of these investments with the new cash, thereby reducing future taxation. 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 73.
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.
Just 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.
1: Giving USA 2023: The Annual Report on Philanthropy for the Year 2022, a publication of Giving USA Foundation, 2023, researched and written by the Indiana University Lilly Family School of Philanthropy. Available online at www.givingusa.org.