Tax Planning and Donor-Advised Funds: A Strategic Approach

Date January 19, 2024
Article Authors

In the realm of philanthropy and tax planning, donor-advised funds (DAFs) have emerged as powerful tools for individuals and families seeking to create a meaningful legacy while optimizing their financial and tax strategies. DAFs provide a flexible and tax-efficient way to contribute to charitable causes, allowing donors to manage their giving and capitalize on the associated tax benefits.

A donor-advised fund is a charitable vehicle that allows individuals to earmark cash or non-cash assets for future charitable endeavors and receive immediate tax benefits, as well as to direct grants to their favorite charities over a period of time. These funds are typically managed by sponsoring organizations, such as community foundations or financial institutions, providing donors with a hassle-free and cost-effective way to organize their charitable giving.

Tax benefits

Donor-advised funds offer donors multiple tax benefits:

  • Immediate tax deductions: One of the primary advantages of using a DAF is that the tax deduction is available when you make the contribution. Your contribution is considered a charitable contribution and reported as an itemized deduction. This deduction can be particularly beneficial for someone with substantial earnings in a year, helping to offset their taxable income.
  • Capital gains tax avoidance: Donating appreciated non-cash assets to a DAF, such as stocks or real estate, can be a savvy tax planning move providing a two-fold tax benefit. By contributing assets such as stock or real estate, donors receive both a deduction for the fair market value (FMV) of the assets and avoid recognition of capital gain income that would have been required if the non-cash assets were sold instead of donated.
  • Flexibility in grant-making: Even though the donor receives an immediate tax benefit, the DAF allows distribution of the donated assets from the fund to qualified charities over time. In other words, you can contribute assets to a DAF, receive a charitable donation tax deduction, and then decide which qualified charities receive the funds at a later time. This allows for strategic and intentional giving aligning with the donor’s values and priorities.
  • Estate tax planning: DAFs can play an important role in estate planning by allowing donors to remove assets from their taxable estate. The DAF also allows the donor to designate a successor fund advisor or fund beneficiaries which ensures the fund can continue to support charitable causes even after the donor’s passing, potentially reducing estate taxes and leaving a lasting legacy.

As such, a DAF can be a helpful and important tool in the tax planning toolbelt. The following strategies only scratch the surface of how a DAF can be integrated into your annual tax planning strategies:

  • Bunching contributions: Bunching contributions involves consolidating several years of charitable giving into a single tax year. By contributing to a DAF in a high-income year, donors can maximize their tax deductions, potentially surpassing the standard deduction threshold and then some.
  • Tax bracket optimization: DAFs provide an opportunity to optimize tax brackets by strategically timing contributions and amounts. Donors can leverage DAFs to “smooth out” income spikes, staying within lower tax brackets and minimizing their overall tax liability. Working closely with a tax advisor can ensure the amount being contributed to a DAF in any year supports the donor’s tax strategies in a precise manner.
  • Strategic asset contributions: As previously mentioned, donating appreciated assets to a DAF allows donors to avoid capital gains taxes. This strategy can be particularly advantageous when rebalancing investment portfolios or divesting assets with significant appreciation. This strategy can also be integrated, working in parallel with a donor’s estate plan by removing highly appreciated assets from the donor’s taxable estate and ensuring future appreciation occurs outside the donor’s estate.

In conclusion, donor-advised funds offer a dynamic and tax-efficient solution for individuals and families seeking to align their charitable giving with their financial goals. By leveraging the immediate tax benefits, avoiding capital gains taxes, and strategically planning contributions, donors can make a lasting impact on the causes they care about while optimizing their overall financial strategy. As always, it is advisable to consult with your financial advisor and tax professional to tailor your DAF strategy to your circumstances and goals.

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