If you are charitably inclined, you may be looking to increase your activities in light of the effects of the recent recession on your favorite charities. Two charitable giving vehicles to strongly consider are the Donor Advised Fund (DAF) and private foundations.
What is a Donor Advised Fund?
Sometimes referred to as a “light” version of a private foundation, a Donor Advised Fund is typically easier to set up and maintain. Generally, creating a Donor Advised Fund requires no more than completing a short application and making an initial contribution as low as between $5,000 and $25,000 to a sponsoring organization, such as a non-profit community foundation. The sponsoring organization takes care of the record-keeping and manages the Donor Advised Fund.
With a Donor Advised Fund, each year you recommend which charities should receive gifts from the sponsoring organization. You may make contributions from a variety of asset classes, such as cash, securities, mutual funds and real estate. Just be sure to check with your sponsoring organization to see if it has any contribution restrictions.
Because a Donor Advised Fund is a charitable fund sponsored by a public charity, it qualifies as a public charity for tax purposes. This means your annual contributions are subject to the highest Adjusted Gross Income (AGI) limit under tax law – a 50% of AGI limit for cash contributions and a 30% of AGI limit for contributions of appreciated assets. Essentially, you make an irrevocable contribution which you can immediately deduct on your tax return even before the funds are distributed. Additionally, there are no minimum distribution requirements and donations can be anonymous.
In the minus column, when you contribute assets to a Donor Advised Fund, the sponsoring organization becomes their legal owner and it isn’t required to follow your wishes as to how they’re used, though Donor Advised Funds generally do follow their donors’ wishes. In addition, the Donor Advised Fund can’t make contributions, such as a scholarship, to individuals or to foreign charities.
When is a Private Foundation More Appropriate than a Donor Advised Fund?
If you want to give away a large sum of money, a private foundation may be right for you. Initial contributions generally are significantly higher than for a Donor Advised Fund — typically starting around $250,000 to make the additional setup and maintenance costs worthwhile.
Creating and operating a private foundation is indeed a considerable step up from a Donor Advised Fund. A private foundation is an independent legal entity that requires complex financial reporting and record-keeping. Its main advantage over a Donor Advised Fund is that you can control (rather than just recommend) how your contributions are used. Additionally, unlike a Donor Advised Fund, a private foundation can make gifts directly to individuals or to non-domestic charities (if certain guidelines are followed), as well as to domestic charities.
In a nutshell, you create a private foundation as a notfor-profit trust or corporation that accepts charitable contributions. The foundation’s board of directors, composed of you and trusted family members, friends or advisors, manages the foundation’s assets and directs grants to other charities. Private foundations may exist in perpetuity, creating a legacy vehicle for future generations.
Annual deductions for contributions to a private foundation are subject to tighter limits than those that apply to Donor Advised Fund contributions – a maximum of 30% of AGI for cash contributions and 20% for contributions of appreciated assets. Generally, private foundations must pay out 5% of the fair market value of the foundation’s assets each year or the foundation may find itself subject to an excise tax. Also, private foundations pay taxes on investment income.
Making the Right Choice
If you’re charitably inclined and ready to greatly increase your contributions, it’s wise to learn more about Donor Advised Funds and private foundations.
Because there are strict IRS rules to follow for both a Donor Advised Fund and Private Foundations, talk to your Untracht Early tax advisor to learn the details of each one.