Donor-Advised Funds are the fastest growing vehicles for charitable giving in the United States, and for good reason. They combine the high tax deductions of gifts to public charities with much of the personal involvement and customization enjoyed by those who have their own private foundations. Since 2012, contributions to DAFs have doubled, accounting for more than $7 billion in 2017, and they are set to keep growing.
The Higher Standard Deduction May Eliminate Tax Benefits of Charitable Contributions
Part of that new expected growth is related to a new set of tax rules that came into effect on January 1, 2018. In exchange for eliminating a bunch of other tax deductions, Congress has increased to $12,000 the so-called “standard deduction,” the amount that each person can deduct from her income each year if she chooses not to “itemize” her deductions. The key itemized deductions are the home mortgage interest deduction (now much more limited than it used to be), the state and local tax deduction (now capped at $10,000 per person), and the charitable deduction. A person who has more than $12,000 (or $24,000, for a married couple filing jointly) of these tax deductions will itemize – otherwise, she’ll take the standard deduction. As many as 20 million more Americans than in previous years will not have enough itemized deductions to exceed the new, higher standard deduction – for those taxpayers, their charitable contributions will no longer provide any tax benefit at all.
Strategies for Maximizing Tax Benefits of Charitable Gifts
There’s a relatively easy way around this, a strategy known as “bunching.” Imagine that someone regularly gives $5,000 per year to charity, and has $5,000 of other itemized deductions each year. Because the $12,000 standard deduction is higher, those itemized deductions do no good. However, imagine instead that the same donor gives $25,000 to charity in one year, and nothing for the next four years. She still gives the same aggregate amount to charity – however, in the year of the gift, she has $30,000 in itemized deductions, which exceeds the standard deduction, while claiming the $12,000 standard deduction in the other years. By “bunching” her contributions in this way, she gets a total of $78,000 in deductions over a five-year period, rather than $60,000 for claiming the standard deduction alone each year, which restores at least some of the tax benefits of making charitable gifts.
The key problem with this “bunching” strategy is that the donor may not want to give $25,000 in one year and nothing in other years – there may be good reasons why she wants to spread out her gifts evenly. That is where donor-advised funds come in.
Establishing a DAF
A donor-advised fund is a discrete account set up within a public charity. It can be named after the donor (for example, the “Mary Donor Charitable Fund,” or in some other fashion. While the charity controls the fund, the donor has the ability to provide advice regarding where contributions should go. For example, she can make that $25,000 gift to the fund once every five years, but then recommend that the fund spread that out in $5,000 annual payments to her favored charity, just as she was doing previously. And unlike a direct $25,000 gift to her favored charity, using a DAF also gives her the opportunity to recommend redirection of future year gifts to different charities if she decides that the funds will be better used elsewhere. As advisor to the DAF, she can continue to remain connected and engaged with her favorite causes and charities.
Now is the Time to Act
Establishing a donor-advised fund is easy – however, it is important to coordinate establishment and funding of the DAF with your personal tax and cash flow situation. The new tax law creates one reason for setting up a donor advised fund, but, as noted above, there are others.
If you think you might want to establish a DAF before the end of the year, you should begin this process as soon as possible – many DAF sponsors have tight deadline requirements (beginning as early as November in some cases) for those who want to establish DAFs and complete gifts before the end of the year.
About the Authors
Brad Bedingfield is counsel at Hemenway & Barnes LLP. Brad works extensively with nonprofit organizations, navigating tax, regulatory, and governance matters, guiding charities and other nonprofits through formation, reorganizations, mergers, affiliations, and dissolution, and advising on innovative use of charitable assets, including social impact bonds and other forms of impact investing. Email Brad
Andrea Richmond serves as a Family Office Advisor at Hemenway & Barnes. She concentrates her practice on a wide range of complex Family Office and Philanthropic Services relating to trust and estate planning, tax planning, investment management, philanthropic giving, nonprofit advising, and nonprofit administration. Email Andrea