By Dan Owens, CPWA®
Benjamin Franklin is quoted as saying that the only certainties in life are death and taxes. While we may not be able to avoid either one, there are plenty of ways we can help reduce our tax burden and increase our savings. One such way is through a donor-advised fund. A donor-advised fund (DAF) is a charitable investment account that allows you to lower your taxable income through contributions, then choose organizations to support, either immediately or in the future. It’s a win-win situation. Here’s some of what you need to know about this unique tax-saving strategy.
Charitable Giving Under the Tax Cuts and Jobs Act (TCJA)
Before we explain what DAFs are, it’s important to mention the changes in charitable giving under the Tax Cuts and Jobs Act (TCJA). Essentially, the tax benefits for charitable giving have been reduced by more than 30% since the TCJA went into effect in 2017. If you’re charitably inclined, you’re probably used to itemizing your deductions. However, with the increased standard deduction and the limit on deductions for state and local taxes, you may not have received as much of a tax benefit for your giving in the past few years (since the TCJA went into effect in 2017) as you may have previously. Using a DAF is one strategy to help maximize the tax benefits of charitable giving.
What Is a Donor-Advised Fund?
Essentially, a donor-advised fund is a philanthropic investment account that is funded with irrevocable, tax-deductible contributions. After making a contribution, a donor can direct how the funds are invested (stocks, bonds, ETFs, etc.), then make gifts to most charitable organizations as the donor chooses. One important thing to keep in mind: once you put an asset into a DAF, you can’t take it back.
Because of this, your contributions are considered a completed charitable gift and are immediately tax-deductible. You can take the tax deduction right away even if you wait several years to pass the money on to charity. Though you don’t technically retain ownership when you put money or assets into a DAF, you are still able to guide investment selection and recommend which organizations will receive contributions from the DAF. You can name your DAF account, as well as your advisors, successors, and beneficiaries. The “administrator” of the DAF makes the ultimate decision on where the funds go, but if you’re worried about not having as much control of your money, know that most DAF administrators will honor donor wishes, as long as the recommendation complies with legal and tax requirements and grant-making policies.
Tax Benefits of a Donor-Advised Fund
DAFs offer several tax benefits. First, you get to take an immediate deduction when you contribute, even if the money has yet to be given to the charity of your choice. Any limit to the deduction you’re allowed to take depends on what kind of assets you contribute to the DAF.
Publicly traded securities are a popular asset to contribute to a DAF. This is because you can avoid paying long-term capital gains taxes and still deduct the fair market value of the securities (those held over a year). If you buy a security at $100 and put it in a DAF when it’s worth $200, you get to deduct $200 of taxable income, while paying $0 on the gain on the stock.
Contributions of long-term capital gain property to a DAF, such as appreciated securities, can be deducted up to 30% of your adjusted gross income (AGI). For all other cash contributions, you can deduct up to 60% of your AGI. If your contributions exceed your deductible limit, you can carry the deduction forward for up to 5 years, if needed.
Also, all contributions can be invested within the DAF to grow tax-free. Once assets are in a DAF, they belong to charity and are therefore exempt from taxes.
How Are Donor-Advised Funds Used?
Using a DAF can lead to more deductions over two years. Following is an example of savings in the 24% tax bracket and additional benefits from donating appreciated securities.
Let’s take a look at an example. The 2022 standard deduction for a married couple filing jointly is $25,900, and $27,700 in 2023. Assume that you have been donating $15,000 per year to charity. When combined with your property taxes and mortgage interest, you have total itemized deductions of $31,000 each year. That means you only receive a tax benefit for $5,100 of your giving in 2022 and $3,300 in 2023. Your total tax deductions over the two years are $62,000.
Now, instead, imagine that you open a donor-advised fund in 2022 and contribute $30,000 to it to cover your charitable giving for 2022 and 2023. In 2022, you will have itemized deductions of $46,000 ($16,000 of mortgage interest and property tax combined with $30,000 contributed to a DAF). Then in 2023, you can simply take the standard deduction since you have no charitable giving to report. Your total deductions over the two years will be $73,700.
By using a donor-advised fund, you end up with $11,700 more in deductions over two years. If you are in the 24% tax bracket, that’s a tax savings of over $2,800. If you donate appreciated securities to the DAF, your tax savings will be even greater because you will not face capital gains tax on the disposal of the securities. This strategy is also called “bunching,” because several years of charitable contributions are “bunched” into one year.
Is a Donor-Advised Fund Right for You?
If you’re already donating to charities and organizations that you care about and you want to maximize the tax benefits and flexibility of those gifts, a DAF could be a great option.
Another great time for a large DAF contribution would be in a year with a large income event, like the sale of a business. Selling a business for $50,000,000 likely comes with a large tax bill. Contributing $10,000,000 to a DAF during that year could allow a business owner to save more than $2.3 million in taxes, while not being forced to make a decision on which organization(s) to immediately gift the money. In that case, the DAF could be used over a number of years (or even decades) to support causes that are close to the family’s heart.
At Elk River Wealth Management, we would be pleased to partner with you to determine the best strategy for your tax-efficient giving. We specialize in delivering comprehensive wealth management services with a personalized touch. If you want to see if a DAF is the right fit for your goals or explore any of our other financial services, call our office today at (720) 452-1901 or email email@example.com.
Dan Owens is a Managing Director and Senior Wealth Advisor for Elk River Wealth focusing his efforts on the Arizona market. Dan has over 20 years of experience in the financial services business and is a Certified PrivateWealth Advisor® (CPWA®). Dan values building relationships with clients and focuses on the financial needs of individuals, families, and business owners. Dan enjoys what he does and is dedicated to helping people successfully navigate the complexities of the financial system. Since moving to Arizona in 2003, Dan has been an active member of the community, volunteering for projects and organizations that support the greater Arizona community. He has served on local boards, committees, and foundations, including UMOM, HandsOn Greater Phoenix, SARRC, CoBiz Cares Foundation, and CoBiz Biz Bash. Today, he is a proud member of the Team Bradley Bear board helping families struggling to pay bills while battling pediatric Cancer.
Dan met his wife, Kim, while both were volunteers and together remain passionate about helping others. They make their home in central Phoenix and enjoy riding bikes, hiking, and other outdoor activities with their two children.