Donor-advised funds (DAFs) are charitable vehicles into which donors can transfer assets, receive immediate tax benefits, and have the freedom to choose qualified charities for the funds on their own timetable. Low-basis assets can be sold within a DAF without being subject to capital gains tax, which can be extremely beneficial in maximizing the amount a person is able to donate.
Take, for example, a stock that you bought at $10,000 and sold at $100,000. Normally there would be capital gains taxes on the $90,000 profit. That tax can be as much as 23.8% or $21,420 in this example. This would only leave you $78,580 after taxes. However, if that stock was transferred to a donor-advised fund and then sold, there would be no tax consequences, allowing charities to receive the full benefit of the $100,000.
How donor-advised funds compare
DAFs allow a donor to take a charitable deduction in the year they put their assets into the fund, even if the assets aren’t donated to charity right away. This can make a DAF helpful for earmarking a certain amount of money for charity, leaving the donor time to research organizations and donate the full amount when they’re ready — or give a small portion annually over a period of years.
While it’s also possible to donate a stock directly to a charity and avoid capital gains taxes, the process of doing so can be time-consuming, presenting a challenge for charitable organizations that receive their highest number of donations at the end of the year. Additionally, this process would have to be repeated each time the investor wants to donate a stock. Another option would be to establish a foundation, but that strategy also has its own complexities, including having to file a separate tax return each year.
The role of charitable sponsors
DAFs are established in partnership with an IRS-recognized charitable sponsor, which manages and administers the fund on the donor’s behalf. Under this arrangement, the donor recommends recipients for the fund assets and the charitable sponsor gives final approval. Usually this is a formality, but in isolated cases, such as if the donor wants to give money to a hate group, the sponsor has the power to say no.
Sponsoring organizations are relatively easy to find. Many 501(c)(3) charities act in this role, and Argent itself has a foundation that manages donor-advised funds.
Strategies for DAFs
For clients who have not established a DAF yet, starting one now can still have benefits. During periods of market volatility, investors may be reassessing their investment allocation. If rebalancing makes sense but you don’t want to realize significant capital gains, donating to a DAF can help you reposition your portfolio and get a tax deduction in the process.
The tax deduction you receive for contributing to a DAF can also be beneficial if you need to offset other taxable income for the year. With many retirement accounts down double-digits, a Roth conversion may be a prudent move for some clients. This approach allows assets to grow and be distributed in the future tax-free, though you do have to pay income taxes in the year of conversion. Offsetting this additional income with a contribution into a DAF can help minimize the overall tax impact.
In certain years, there might be tax reasons to give an increased amount to charity. Since the Tax Cuts and Jobs Act became law in 2017, the standard deduction for individuals and couples has nearly doubled in size from its former level. However, now it may make sense to consider “bunching” together itemized deductions from two years into a single year, then take the standard deduction the other year. Using a DAF makes it easy for a charitably inclined donor to use this strategy, maximizing their tax benefits while benefitting charities they care about.
Once funds are contributed into a DAF, a donor has infinite possibilities on how they can help charitable organizations who are feeling the pain of record inflation. If you think a DAF might be a good option for your charitable giving, we’d be glad to help you establish one or answer any questions you might have. Contact one of our advisors if you’re interested in learning more.