Donor-advised funds, which are increasingly popular vehicles for charitable and tax planning, could face new restrictions thanks to a recently introduced U.S. Senate bill. But even if the bill becomes law, we believe DAFs will continue to be attractive.
DAFs have been around since the 1930s, but their widespread adoption began in the 1990s, and they’re now one of the main options for charitable planning. Charitable planning, whether it uses a DAF, a private foundation, or another vehicle for giving, lets families combine their desire to support worthy causes with minimizing taxes on current and future generations.
Donor-advised funds are charitable giving accounts run by a sponsoring organization—either a specific charity or community foundation, a religious organization like Jewish United Fund or Catholic Charities, or the arm of a financial firm such as Fidelity, Schwab, or Vanguard.
Contributions to DAFs totaled nearly $48 billion in 2020, according to the National Philanthropic Trust. Donors contribute cash, securities, or tangible assets such as real estate or jewelry, and receive an immediate tax deduction—up to 60% of adjusted gross income for cash donations, and up to 30% for securities and other assets. Donors then recommend grants from the fund to specific nonprofit organizations. The disbursements can be made all at once or over time, and to one charity or multiple charities. Donors also retain control over how to invest the assets, and any growth that occurs is tax-free.
Deductions for highly appreciated assets can be particularly valuable, as the assets are removed from donors’ taxable portfolios and neither the giver, the DAF, or the ultimate recipient must pay a capital gains tax.
DAFs allow households to choose charities in a thoughtful, unhurried way. Often, those who receive a windfall such as the proceeds from the sale of a business, a big work bonus, or an inheritance, find themselves scrambling to give money away by the end of the calendar year in order to avoid a major tax bill. Donor-advised funds function as a tax-advantaged holding area for assets to be donated to the right charity at the right time.
The funds have become more attractive to many taxpayers since the 2017 Tax Cuts and Jobs Act made it harder to claim charitable deductions. Relatively small annual charitable donations might not be tax-deductible, but “bunching” several years’ worth of donations into a DAF can push donors over the threshold for deductions. After that, of course, charitable contributions can be parceled out over time.
Technically, DAFs are not required to ever distribute their assets to working charities—they can be a perpetual holding area. That’s the issue that Senators Angus King, an independent from Maine, and Chuck Grassley, an Iowa Republican, address in their bill, dubbed the Accelerating Charitable Efforts (ACE) Act. The act replaces the conventional donor-advised fund with a 15-year DAF and a 50-year DAF.
Donors using the 15-year fund would still get up-front tax benefits, but only if assets in the fund are distributed within 15 years of the donation, or if the donor relinquishes decision-making power.
Donors wanting more than 15 years to distribute their assets would use the 50-year fund. They would still receive capital-gains and estate-tax benefits upon donation. But the income-tax deduction would only kick in once the donated funds are distributed. And all funds would have to be distributed within 50 years.
The bill also takes aim at asset overvaluations. It mandates that tax deductions for complex assets, like closely-held or restricted stock, be based on the cash proceeds of the sale of the assets and not their appraised value. It would also block private foundations from using donations to DAFs to meet their requirement of disbursing 5% of their assets annually.
The ACE Act is an early step in what could be a long process, and there’s a good chance that it could be changed significantly, or never passed into law. But even if the bill does become law in its current form, we believe there would still be a strong case for DAFs, based on their tax benefits and the flexibility they offer for charitable planning.
DAFs are not the best solution for all who are charitably inclined. Some wealthier individuals and families may prefer to create private foundations, which have more grantmaking flexibility than DAFs. Private foundations can grant scholarships and fellowships directly to individuals and make direct donations to those facing financial challenges, for example. Private foundations are more costly than DAFs to administer, however, and as noted above, they must give away at least 5% of their assets annually—a requirement that, at least for now, does not apply to DAFs.
At AdvicePeriod, charitable giving and tax management are two areas we’re passionate about helping clients with. Please don’t hesitate to contact us if you would like to discuss the topic.