Tactical Analysis: Donor Advised Funds

So far we’ve gone through the first four steps of the Tactical Philanthropy process. You can click on the links to read about Goal Establishment, Legacy Planning, Asset Analysis, and Tactical Analysis. After giving an overview of the Tactical Analysis step, I gave a case study. Today I am going to talk about the second of the five major giving vehicles

• Private Foundations
• Donor Advised Funds
• Charitable Remainder Trusts
• Charitable Lead Trusts
• Supporting Organizations

While private foundations have gotten much cheaper and easier to operate than they have been in the past, donor advised funds (DAF) are still the cheapest and easiest giving vehicle. If the majority of your charitable giving is made up of writing checks to nonprofits, then a DAF is likely a great choice.

A DAF is an account, held at a charitable organization, on which a donor is named as advisor. In practice, a DAF acts like a charitable checking account. The donor gets an income tax deduction when assets are placed in the account and can then send checks out of the account to the nonprofits he or she wishes to support. Legally, the donor only has the right to “advise” the charity that controls the account regarding which charities to support. This lack of control is in contrast to a private foundation, which the donor controls absolutely. But in practice, charities deny donors’ “advice” in only the most extreme cases.

While donor advised funds cannot make loans, pay for donors’ charitable expenses, invest in nonprofits or engage in other sophisticated philanthropic strategies in the way that private foundations can, they are incredible easy to use and can be opened with as little as $5,000. Private foundations, while not requiring the $3-$5 million in starting capital that many people assume, still generally require at least $250,000.

Donor advised funds also offer the benefit of offering tax deductibility for assets other than cash or common stock (private foundations can accept any type of asset, but only offer a tax deduction for the cost basis of assets other than cash and common stock).

Some examples:

• Real Estate: The great real estate boom seems to have come to a halt. Donors with holdings in investment properties should think about using these assets to fund their giving. Both complete and partial gifts of real estate to nonprofits should be considered. If multiple nonprofits are contemplated as recipients, or if endowing future years’ giving is desired, real estate can be used to fund a donor advised fund.
• Privately held business interests: If you are a partner in a privately held business or the owner of a family firm, you can use this asset in your giving. One obvious time to consider this option is when a family seeks to sell a family business that they have built up over the years. The sale of the business will trigger a large tax bill. By gifting a partial interest to a nonprofit or donor advised fund, the family can offset part of the tax from the sale. Recently the rules regarding gifts of assets held inside of an S-Corporation were changed. These assets had been an ineffective choice for giving in the past, but at least until December 31, 2007 these assets can be a tax efficient choice.
• Odds & Ends: Artwork, life insurance, coin collections, intellectual property, The Minnesota Vikings… Almost any asset can be gifted to a nonprofit. The structure of the gift and the nonprofit receiving the gift both play into the tax ramifications. The last time the Minnesota Vikings were sold, my friend Bryan Clontz was involved in handling a gift of a partial share of the team into a donor advised fund.

Setting up a donor advised fund also allows donors to separate the tax side of their giving from their charitable intent. Since the tax deduction occurs when assets are placed in the account, this decision can be made with the donors CPA or financial advisors. Making gifts out of the fund to a nonprofit has no tax implications, and so the donor can make these decisions without concerning themselves with the tax impact of the timing or size of the gift.

Donor advised funds are also ideal vehicles for use by giving circles. Assuming the giving circles is started with at least $5,000, the group can start a donor advised fund to hold their assets. The treasurer or other member of the group can be named as the advisor to the fund and each member would receive a tax deduction for their gift to the fund in the same way they would for a gift to any public nonprofit.

One thing to keep in mind is that the choice between a private foundation and donor advised fund is not an either/or situation. While the media has made much of donor advised funds being the “next” privation foundation, in actuality they are distinct strategies that can be employed separately or in combination. Many large private foundations also set up a donor advised fund “side car” to receive gifts or assets other than common stock and cash, as well as to receive a portion of the private foundations 5% minimum distribution in years when the foundation does not find enough nonprofits it wants to fund.

Benefits:

• Simple, effective way to organize your giving and maximize tax deductions with limited paperwork.
• Fund your giving with any assets (such as real estate or privately held business interests), not just cash or common stock.
• No excise tax, such as the 1-2% tax levied on private foundations
• No liability or compliance risk since the account is legally controlled by the sponsoring nonprofit.

Drawbacks:

• Can only use fund to write checks to nonprofits. Making loans to nonprofits or paying for charitable expenses not allowed.
• No formal structure for involving your family members.
• Can only make gifts to IRS recognized, US based nonprofits. No emergency grants to individuals, scholarships or international grants allowed.
• No legal control over the account. The assets in your fund are legally controlled by the sponsoring nonprofit.

Donor advised funds are offered by individual nonprofits, community foundations and national donor advised funds (such as Schwab Charitable and the Fidelity Charitable Gift Fund). Opening an account with an individual nonprofit might make sense if you give a large portion or your charitable dollars to that organization. Starting one at a community foundation is best if you want to use the foundation’s “strategic advice” (advice on where to give). Community foundations generally charge a fair bit more than national donor advised funds, but provide very good advice on identifying nonprofits you might want to support. If you are generally self-directed and do not need advice on where to give, a national donor advised fund is probably best. These nonprofit entities offer a simple donor advised fund structure and charge low fees.