Charitable giving is generally a component of a comprehensive tax or estate plan. Receiving a tax benefit for charitable donations used to be a straightforward exercise for taxpayers who itemized deductions. Taxpayers simply made a contribution to a charitable organization and included their donations on Schedule A, Itemized Deductions.
Things got a little complicated, however, with the passage of the Tax Cuts and Jobs Act in 2017, when the standard deduction was increased and the deduction for state and local taxes was capped at $10,000. The result was a dramatic decrease in the number of taxpayers claiming itemized deductions, and a corresponding decrease in charitable donations due to the diminished tax benefit.
Rest assured, there are still ways for philanthropically-minded taxpayers to squeeze tax benefits out of their charitable giving.
One way for taxpayers to increase their itemized deductions to an amount above the standard deduction is to use a strategy known as bunching, in which taxpayers bunch two or more years of charitable contributions in one year. The taxpayer itemizes deductions in the contribution year and gets an increased deduction for his or her charitable contributions in that year, while taking the higher standard deduction in the year without contributions.
While wanting the tax benefit of making large contributions in one year, many taxpayers also want to spread out when the charity actually receives the contribution over a longer period. A donor-advised fund (DAF) allows a taxpayer to achieve both of these objectives.
What Are Donor-advised Funds and How Do They Work as a Tax Planning Strategy?
A DAF is a private fund administered by a third party, called the sponsoring organization, created for the purpose of managing contributions made by donors.
Donors contribute assets, be it cash or non-cash, to a DAF. Donors can deduct the full amount right away from that year’s taxes, up to 60% of adjusted gross income (AGI) for cash donations and up to 30% of AGI for non-cash donations. Non-cash donations, such as stocks, mutual funds, private S-corp stock, etc., allow the donor to take a tax deduction equal to the fair market value of the appreciated asset contributed while avoiding any capital gains tax.
Once donated, the assets must eventually go to a nonprofit organization, but there’s no time limit for this to occur and the assets can be invested and continue to grow. This allows the donor to take an immediate tax deduction while affording them the time to spread the donations to the charitable organizations over multiple years.
Reasons to Add Donor-advised Funds to Your Tax Plan
DAFs, unlike private foundations, require minimal administrative work on the part of the donor, are relatively easy to establish, and do not have minimum payout requirements.
DAFs have become increasingly popular because of their giving versatility, low administrative requirements, immediate tax benefits and ability for donated assets to grow tax free. And, DAFs offer a tax-efficient way to build a charitable legacy. If charitable giving is a part of your tax or estate plan, or you would like it to be, you should consider whether a DAF is right for you.
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