Charitable giving is an opportunity to use your wealth to benefit others while providing you with tax benefits. If you’re searching for a way to reduce your tax bill and give back to the community, a donor-advised fund (DAF) or a private foundation (PF) may be worth considering. Here is what you should know about DAFs and PFs to help you determine which is suitable for your situation:
Donor-advised funds (DAFs)
DAFs are owned and controlled by a sponsoring organization such as a non-profit organization, charity, educational institution, or religious organization. A DAF is a giving account that enables funds to remain inside the DAF until the charity uses them later. DAFs do not need to make a minimum distribution each year and have no timeline of when they must distribute the funds to the charity unless it has $1 million or more, requiring the DAF to distribute 4% of assets annually.
When a donor contributes to the DAF, they immediately receive a tax write-off. However, the charity does not always receive the benefit (grant) immediately, sometimes not for years. The donor can recommend to the sponsoring organization how the funds are invested and granted but gives up all legal control of the DAF.
The sponsoring organizations may restrict granting activity, such as a minimum or maximum dollar amount or the number of grants per year, before any remaining funds revert to the sponsoring organization. Here are other things to consider before using DAFs for your charitable giving:
- DAFs often have a limited choice of investment options
- Assets used to fund a DAF may be liquidated upon donation, which can result in additional transaction fees.
- Can only grant to 501(c)(3) public charities
- Can’t convert to a private foundation
- DAFs do not create a permanent legacy
Private Foundations (PFs)
PFs are legal entities classified as tax-exempt, 501(c)(3) organizations by the IRS that generally have one funding source, such as an individual, a family, or a corporation. PFs give the donors control over granting and investment decisions, the mission of the PF, where the assets are invested, managers, and to whom and when the funds are granted.
PFs can be funded with almost any asset- private equity, tangible assets, real estate, and intangible personal property. A private foundation can perpetuate creating a legacy that encourages family giving across the generations. PFs can grant in various ways, for example:
- Granting to individuals
- Granting through scholarship programs
- Providing program-related investments
- Giving through direct charitable activities
- Participating in International granting
Private foundations are required by the IRS to distribute 5% annually the fair market value of their assets each year for charitable purposes, including grants to other charitable organizations, to benefit society.
How donor-advised funds and private foundations differ
|Donor-advised funds (DAFs)||Private Foundations (PFs)|
|Convertible?||No||Yes- convert to a DAF|
|Start-up time||Immediate||Can take weeks or months|
|Start-Up costs||None||Legal and other fees|
|Tax deduction limit – $||60% of AGI||30% of AGI|
|Tax deduction limit – stocks, real property||30% of AGI||20% of AGI|
|Valuation of gifts||Fair market value||Fair market value for publically traded stocks, cost basis for all other gifts|
|Required distribution||No||5% of net asset value|
|Privacy||Donors are not disclosed to the public||Must file informational returns that are available to the public|
Your financial and legal professionals can help you understand the differences between a donor-advised fund and a private foundation and help you determine which is appropriate for your unique situation.
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual.
This information is not intended to be a substitute for specific individualized tax advice. We suggest that you discuss your specific tax issues with a qualified tax advisor.
All information is believed to be from reliable sources; however LPL Financial makes no representation as to its completeness or accuracy.
This article was prepared by Fresh Finance.
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