Especially during tax time, philanthropic individuals have many options to consider in selecting their optimal charitable giving strategy. Depending on purpose and donor intent, a private foundation or a donor-advised fund (DAF) may be the best vehicle to accomplish one’s charitable goals. Considerations in deciding between a private foundation or DAF include the importance of retaining control by the donor, the size of the charitable donation, and the donor’s capacity and interest to participate in ongoing administration. Our discussion below refers to a private non-operating foundation that is focused on grantmaking to nonprofit organizations, rather than a private operating foundation that may provide charitable services and programs of their own.
Private Non-Operating Foundation:
The private non-operating foundation is generally founded by an individual, married couple, family, or company to fulfill a charitable mission. The foundation is referred to as private due to the concentrated source of funding that may come from one individual, family or close-knit group as opposed to seeking financial support from the public. Since the foundation is not dependent on public support, the founding individual or family maintains financial control. The assets donated to the foundation, set aside for charitable purposes, are invested to generate income for grants. Depending on how the foundation is structured, the foundation is governed by a board of directors or one or more trustees that may be comprised of family members, donors or other related individuals. The foundation enjoys tax-exempt status if certain federal and state requirements are met.
The foundation is required to file an annual tax return and must make a minimum distribution for charitable grants each year, approximately 5% of the average market value of their assets with certain adjustments. If the minimum distribution is not paid, the foundation may be subject to a 30% penalty on the undistributed amount. The setup and professional administration costs of creating and managing the foundation may be cost-prohibitive for smaller contributions. Due to the cost of the legal and professional work needed to start and administer the foundation, some advisors suggest it may take a minimum contribution of $2,000,000 to $5,000,000 to justify the costs.
A donor’s tax-deductible contribution to the foundation is subject to 30% of adjusted gross income (AGI) limitation for cash contributions and 20% of AGI for noncash contributions. Donations that exceed AGI limitations can be carried forward for five years. Advantages of the private foundation include tax deductibility of donations, retention of control over grantmaking and investments, the ability to employ and compensate family members to assist in running the foundation and the ability to make grants to individuals for travel, study, or other similar charitable purposes if certain IRS requirements are met. However, due to initial startup and ongoing time and administrative expenses, the private foundation may be more expensive and time-consuming to operate and is subject to lower tax deductibility income limitations.
Donor-Advised Fund:
A donor-advised fund (DAF) is a fund sponsored by a public charity that allows a donor to make an irrevocable charitable contribution, take an immediate tax deduction and recommend grants from the fund to a variety of qualified charities over time. The donor, or someone appointed by the donor, retains advisory privileges over the investment and distribution of the funds and, if desired, may remain anonymous to the grant recipient. While the tax deduction for a donation to a DAF is immediate, the DAF allows a donor to decide which charity to support over time. DAFs can be established immediately at a low cost with many sponsoring organizations having no or low minimum initial contributions.
Once established, the DAF sponsors handle administrative work such as recordkeeping, grant administration, and annual account summaries. While there are no initial set-up costs, the DAF does require an annual administrative and investment fee. Once assets are contributed to the DAF, the funds can be invested for potential tax-free growth. Because there is no current annual minimum distribution requirement, funds may grow tax-free over time.
Deductions for contributions to a DAF are subject to AGI limitations, 60% for cash gifts and 30% for non-cash assets held more than one year, a higher limit compared to the private foundation. Donations that exceed AGI limitations can be carried forward for five years. Advantages of the DAF include the income tax deduction, no initial startup costs, ease of administration, tax-deferred growth potential, no minimum annual distribution requirement, and an anonymous granting option. However, some sponsoring organizations may be restrictive about grants and a donor should confirm that their recommended grants will be accepted.
The choice between a private foundation and a DAF can be complex. A donor wishing to implement a charitable giving strategy should consult with tax and legal advisors such as a CPA or tax and estate planning attorney to determine the best solution for their personal financial goals.
Source: Schwab Charitable, irs.gov, AICPA, foundationsource.com
