Donor advised fund
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A donor-advised fund is a charitable giving vehicle administered by a public charity and created for the purpose of managing charitable donations on behalf of an organization, family, or individual. A donor-advised fund offers the opportunity to create an easy-to-establish, low cost, flexible vehicle for charitable giving as an alternative to direct giving or creating a private foundation. Donors enjoy administrative convenience (the sponsoring organization does the paperwork after the initial donation), cost savings (a foundation requires around 2.5% to 4% of its assets each year to run), and tax advantages (versus individual giving) by conducting their grantmaking through the fund.
However, from some perspectives, a donor advised fund may have some disadvantages versus a private foundation. Namely, a private foundation can accept donation of unusual or illiquid assets (part ownership of a private company; art; real estate; partnerships or limited partnership shares) which a donor advised fund cannot. This can be a significant consideration in some cases. In addition, the founders/board of a private foundation have complete control over where its giving goes within broad legal bounds. In a donor advised fund, technically, the donor only advises the sponsoring organization where the money should go. While rather rare, a sponsoring organization could conceivably alter the donor's intent. In addition, most donor advised funds can only give to IRS certified 501(c)(3) organizations, ruling out, for example, individual charity, scholarships or direct donations to foreign charities, both things a private foundation can more easily do. Donor advised funds do reap a significant cost advantage (foundations carry a 2.5-4% of assets overhead expense to maintain, a 1-2% excise tax on NET investment earnings and a required 5% spending of assets each year) but may also have one more drawback---limited lifetime. While a foundation can persist theoretically for generations/in perpetuity, some sponsoring organizations impose a "sunset" on donor advised funds, after which they collapse individual funds into their general charity pool.
The New York Community Trust pioneered the development of donor-advised funds in 1931. Although the second such fund was not created until 1935, in the decades since the field has greatly expanded as commercial sponsors, educational institutions, and independent charities started offering the service. Donor-advised funds are the fastest growing charitable giving vehicle in the United States of America, with more than 175,000 donor-advised accounts established, holding over $37 billion in assets.
Because the fund is housed in a public charity, donors receive the maximum tax deduction available, while avoiding excise taxes and other restrictions imposed on private foundations. Further, donors do not incur the cost of establishing and administering a private foundation, including staffing and legal fees. Since the maximum tax deduction is received by the donor at the time of the gift, the foundation administering the fund gains full control over the contribution, granting the donor advisory status. As such, they are not legally bound to the donor, but make grants to other public charities upon the donor's recommendation. Most foundations that offer donor advised funds will only make grants from these funds to other public charities, and will usually perform due diligence to verify the grantee's tax-exempt status.
Current U.S. tax law allows the donor of appreciated securities or other assets to get a tax deduction for the market value of the donation and avoid capital gains taxes. This double tax advantage can make donating appreciated assets to a charitable organization more attractive than selling the assets and donating cash. By donating appreciated assets to a donor advised fund and then advising the fund to make donations to several charities, one can reap these tax advantages without the hassle and paperwork of transferring non-cash assets to several organizations. This combination of convenience and full tax advantage is one reason that donor advised funds are used.
While private foundations in the United States are heavily regulated by the Internal Revenue Service, including rules on oversight and minimum annual payouts, donor advised funds housed in public charities are not subject to the same tax restrictions.
In 1985, National Foundation, Inc. (NFI, now WaterStone ), defended its standard for the management of donor-advised funds against the Internal Revenue Service in the United States tax court in National Foundation, Inc. v. United States. The court found that NFI was eligible for tax-exemption and could be classified as a 501(c)(3) non-profit organization based on their management of donor-advised funds. NFI had complete control and ownership of what would later be called donor-advised funds, and could exercise discretion in authorizing charitable distributions of the funds. Donors maintained advisory privileges, but NFI was not obligated to use the funds based on their recommendations, especially if the receiving party did not comply with the five standards of a charitable organization, identified by the court: 1) that it be consistent with a the charitable purposes specified in section 501(c)(3); (2) that it have a reasonable budget; (3) that it be adequately funded; (4) that it be staffed by competent and well trained personnel; and (5) that it be capable of effective monitoring and supervision by NFI. The outcome of this case opened the door for many other providers to launch donor advised fund programs. On August 17, 2006, President George W. Bush signed the Pension Protection Act of 2006 (H.R. 4) into law, which includes a number of changes to the regulatory framework for donor-advised funds, and follows both House and Senate passage of H.R. 4. the Pension Protection Act of 2006 established guidelines for the management of donor-advised funds, using NFI’s standards as a framework. The sections dealing with donor-advised funds include:
- Legal definition of a donor-advised fund.
- A list of prohibited payments to donors and advisers to donor-advised fund.
- New rules about what grants can be made from donor-advised funds.
- The documentation required for all contributions to donor-advised funds.
Tax efficiency example
The following example is taken from Vanguard’s marketing material for their plan:
Suppose you have 1,000 shares of stock that you purchased 15 years ago (thus, you’re in long term capital gains territory). Assume that you purchased the stock for $10 per share and it is now worth $100 per share. Now, let’s compare the cost to the donor of making a contribution of $100,000 to a charity of your choice. We assume a 35% income tax rate and 15% long term capital gains tax rate.
Option 1: Contribute cash from sale of securities
- Immediate cost of donation: $100,000
- Capital gains tax incurred: $13,500 (15% times ($100k minus $10k))
- Income tax saved: ($35,000) (35% times $100k)
Net cost to donor: $78,500
Option 2: Contribute appreciated securities
- Immediate cost of donation: $100,000
- Capital gains tax incurred: NA (15% times $100k minus $10k)
- Income tax saved: ($35,000) (35% times $100k)
Net cost to donor: $65,000 NOTE: The donor could contribute the stocks directly to the charity of his/her choice, or to a donor-advised fund. The tax efficiency to the donor is the same either way.
Thus, you can effectively contribute $100,000 to the public charity of your choice for $13,500 less in actual donor cost by using the donor advised fund. This example does not acknowledge that the same tax advantage would be obtained if one were to donate the appreciated securities directly to a 501(c)(3) charity, whether it was a donor-advised fund or not, as the charity then sells the assets and the capital gains are avoided.
If the securities increase in value after they have been given to the donor advised fund (but before the grant recommendation is actually made), no additional tax deduction can be claimed by the taxpayer. On the other hand, if the securities decrease in value, the taxpayer's original tax deduction (based on the value of the securities when given to the donor advised fund) continues to be valid.
Even though the tax efficiency is the same, there are some differences between giving directly to the charity and giving via a donor advised fund.
- Some charities are not set up to receive gifts of securities.
- The amount that the donor wants to give to the charity may turn out to be an awkward or small number of shares (for example, it could be administratively complicated to give 5 shares each to 20 charities, but it is easy to give 100 shares to the donor advised fund and then make 20 separate grant recommendations).
- Giving to a donor advised fund allows the donor to take the tax deduction when it is advantageous to him/her. For example a taxpayer can get a tax deduction when he/she gives to a donor advised fund and then take his/her time to decide which charities should be the ultimate beneficiaries.
- Some donor advised funds are able to process gifts to foreign charities. Direct gifts to foreign charities are generally not tax deductible.
- However, there is a cost to using donor advised funds. Most donor advised funds charge an administrative fee (eg 1% per year). This is in addition to any management fees charged by the actual mutual funds that funds are invested in.
- There may be fees charged for every grant, especially if made to a foreign charity.
- National Philanthropic Trust, Donor Advised Fund Report
- Elfreena Foord, Philanthropy 101: Donor-Advised Funds
- Analysis of S. 2020 The Tax Relief Act of 2005
- Pension Protection Act of 2006 (H.R. 4)
- Stock Donator Stock Donations