Charitable deductions are a hot topic in this year’s tax reform debates, but donor-advised funds have been singled out for potential elimination in 2013. Today, donor-advised funds provide a powerful tool to facilitate charitable giving by your upper-middle-class clients and offer a substantial current tax deduction and tax-free growth for contributions.
Donor-advised funds are similar to private foundations but can be used to streamline the giving process for much more modest donations, by allowing for larger deductions and low operating costs. Because of the uncertain future for the tax advantages surrounding charitable giving, your clients should act now to use donor-advised funds to lock in the deduction for tomorrow’s charitable gifts today.
Tax Basics of Donor-Advised Funds
The tax benefits afforded to donor-advised funds are substantial—your clients can deduct up to 50% of their adjusted gross income for cash contributions to the fund and up to 30% of adjusted gross income for donating securities. The deduction is allowable for the current year even if the actual charitable gift is not made until well into the future, so your client is protected against potential elimination of the deduction for future years.
Further, if the gift from the established donor-advised fund is not made until the future, contributions to the fund grow tax-free. For example, if your client wants to make a gift using stock that has appreciated in value, he might sell the stock, pay the capital gains tax on the sale, and give the remaining cash to charity.
But if that same client establishes a donor-advised fund and contributes the stock to the fund, the stock can appreciate in value within the fund tax-free. When it is later donated to charity, the client is not liable for the capital gains tax. The charitable gift is therefore maximized while your client minimizes his tax liability.
Donor-Advised Funds Versus Private Foundations
In theory, establishing a private foundation may seem like an appealing way to establish a systematic practice for charitable giving. However, few of your clients are likely find it to be a worthwhile tool because, while a private foundation can offer a donor more control over the assets, the expense of maintaining the foundation likely outweighs this benefit for most clients.
Private foundations generally provide a way for the very wealthy to establish large and ongoing strategies for charitable giving, but both the startup and maintenance costs are high—administrative costs can be as high as 8% of assets each year. Further, a private foundation is required to donate at least 5% of its assets to charity each year, but no similar requirement applies to donor-advised funds.
The allowable deductions for contributions to private foundations are also lower than those allowed with respect to donor-advised funds—a taxpayer is permitted to deduct only up to 30% of adjusted gross income for cash contributions to a private foundation (20% for contributions of securities).
Conclusion
Donor-advised funds provide a way for your clients to take advantage of the currently available tax deductions for charitable giving, but the time to act is now. By this time next year, tax reforms expected to be finalized later in 2012 could have entirely eliminated the strategy.
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