Now that we understand in tax planning it is all about timing, let’s look at a strategy to maximize your charitable contribution deduction.
Under the Tax Cuts and Jobs Act, itemized deductions changed significantly. In fact, many taxpayers will no longer itemize deductions. This does not automatically make this a bad change for you. It only changes the way you need to think about structuring your deductions.
The standard deduction is at $24,000 married filing jointly ($12,000 single), which creates a larger tax shelter for you. By utilizing the high standard deduction, you may not contribute enough money to charity to exceed the standard deduction and receive the deduction.
Knowing that and knowing about tax timing, your charitable contribution strategy might change. This strategy through utilizing Donor-Advised Funds.
A Donor-Advised Fund is awesome because it allows you to bunch your charitable contributions into one large donation, while enjoying the ability to distribute to your favorite charities when you are ready.
In other words, you take the deduction today and donate the money to your favorite charity tomorrow.
So what is a Donor-Advised Fund?
The IRS definition of a Donor-Advised Fund is:
A Donor-Advised fund is a separately identified fund or account that is maintained and operated by a section 501(c)(3) organization, which is called a sponsoring organization. Each account is composed of contributions made by individual donors. Once the donor makes the contribution, the organization has legal control over it. However, the donor, or the donor’s representative, retains advisory privileges with respect to the distribution of funds and the investment of assets in the account.
The Donor-Advised Fund is like a savings account. It is an account you fill up for a singular purpose to be used later. Inside this charitable savings account, you can invest the funds any way you would like to. Growth on the money is tax-free. This is allowed because the contribution to the account is irrevocable.
Here is the life of a Donor-Advised Fund:
- Contribute money into a designated Donor-Advised Fund
- Invest the money
- Distribute the money your favorite charities
How do I establish a Donor-Advised Fund?
The core purpose of a Donor-Advised Fund is standard, but when it comes to details of the account, it does vary. There are costs to administer the account based on the amount of money contributed to the account. These costs should be minor compared to the tax savings available to you.
The big players in the Donor-Advised Fund arena are Vanguard, Fidelity, Schwab, and National Philanthropic Trust. You can also look closer to home to community foundations and some faith based institutions.
The minimum initial contribution is $5,000 up to $25,000 depending on the institution. Administrative fees are around $1,000 and on-going investment management starts at 0.6% for the first $500,000 invested.
Why should you use a Donor-Advised Fund?
The primary benefit of using a Donor-Advised Fund is to take advantage of tax timing. In essence, by filling a donor-advised fund you are front loading deductions in a higher year and then make distributions to the desired charities in the future.
This might seem silly on the surface, but when playing the tax timing game it makes perfect sense! You create a donation savings account and continue to donate to your favorite charities each year.
We identified that donation of appreciated stock can be a very beneficial tax strategy. One negative against appreciated securities is that not every charity can accept this type of donation. Smaller charities may not have the means or resources to initiate a security sale transaction. However, the Donor-Advised Fund could receive the appreciated security, subsequently sell the security, and then distribute cash to the small charity!
High net worth families may consider creating a Private Foundation. Unfortunately, creating a Private Foundation comes along with more costs and rules (excise tax, self-dealing, excess business holding restrictions, etc.). Because of that, it may not be beneficial to create one. Instead, the utilization of a Donor-Advised Fund is a much less expensive option in both costs and compliance burden.
Who should open a Donor-Advised Fund?
Anybody seeking to make large charitable contributions or is able to bunch multiple year’s worths of donations should consider utilizing a Donor-Advised Fund. More specifically, those seeking to offset higher than normal income are prefect candidates. A few examples:
- Sale of a business
- Sale of highly appreciated stocks
- Receive a large bonus or deferred compensation
- Sale of farm or business equipment
It is also possible to skip the Donor-Advised Fund and simply bunch charitable donations in a given year. However, there might be some dissatisfaction or angst against not donating any additional money for a few years. The Donor-Advised Fund lets you set the money aside and make the donations each year like you are used to while giving you the tax savings you need immediately.
Do you want to understand how to make your money work for you and keep more of what you have earned?
Disclaimer: This article is provided for general information and illustration purposes only. Nothing contained in the material constitutes tax advice, a recommendation for purchase or sale of any security, or investment advisory services. I encourage you to consult a financial planner, accountant, and/or legal counsel for advice specific to your situation. Reproduction of this material is prohibited without written permission from Nate Byers a Madison, WI CPA Financial Advisor, and all rights are reserved. Read the full Disclaimer in the footer below.