An Introduction to Individual Donor Advised Funds | DAF
“An Introduction to Individual Donor Advised Funds,” that’s the subject of today’s ACTEC Trust and Estate Talk.
This is Susan Snyder, ACTEC Fellow from Chicago. To give us an introduction to the rules that govern Donor Advised Funds, you will be hearing today from ACTEC Fellows, Ed Beckwith, of Washington, D.C., and Professor Chris Hoyt, of Kansas City, Missouri. Welcome Ed and Chris.
I am Ed Beckwith. A Donor Advised Fund or DAF is a named fund at a sponsoring public charity. This podcast will review this flexible and attractive charitable giving vehicle.
In a DAF, the donor or the donor’s designee has the privilege of making nonbinding recommendations to the sponsoring organization about which charitable entities should receive grants from the fund and frequently, recommendations about investment of the fund’s assets. Donor Advised Funds have existed since 1931 and play a significant role in building two-way relationships between a sponsoring public charity and its donors. The term Donor Advised Fund was not defined in the Internal Revenue Code or in any corresponding regulations until the enactment of the Pension Protection Act of 2006. While the historic concept of a DAF was reflected in the definition, the Pension Protection Act added a long-standing best practice to the definition. Now, the sponsoring charity must clearly inform the donor that control of the gift will reside with the charity. This is required for the gift to qualify for a tax deduction.
In addition to an expanded definition, the Pension Protection Act imposed reporting obligations on the sponsor and excise taxes on certain distributions from the Donor Advised Funds that fall within the new definition. Chris, tell us more about modern day DAFs.
Well, thank you, Ed. Well, there are 2,400 organizations around the country that sponsor them. Typically, community foundations, Jewish Federations and the National Donor Advised Funds. The National Philanthropic Trust came up with a report that said that at the end of 2017 there were 463,000 Donor Advised Funds. By comparison, there are only 80,000 private foundations and one out of every three Donor Advised Funds today was established in one year and that year was 2017, as a response to the Tax Act, which we are going to talk about. They hold about $110 billion worth of assets. Now, private foundations have seven times as much. They have $800 billion worth of assets. But with the private foundations, it’s kind of like the public, the super-rich. One percent of private foundations hold 62 percent of private foundation assets. In 2017, $29 billion was donated to Donor Advised Funds and $19 billion was paid out. By comparison, private foundations paid out $45 billion but private foundations only distributed about 5.7 percent of their assets, and Donor Advised Funds are like checking accounts. They distribute about 18 percent a year.
Okay. How does a donor create a DAF?
It’s so simple. A donor goes to a sponsoring organization like a community foundation, Jewish Federation, National Donor Advised Funds, and just sets up an account, makes an additional contribution and gives it a name — typically the name of the donor or the donor’s family.
Well, how would it actually work, once I’ve established the DAF?
Well, once the donor identifies a worthy recipient, they’ll recommended a distribution to that public charity or to even a private operating foundation, like a museum or a library.
Why is it that DAFs are so advantageous?
Well, the timing. You can make a very large gift all at once and then distribute amounts over future years.
They say the DAFs are tax preferred. Why is that?
Well, for two reasons. First of all, when you give to a Donor Advised Fund, you are giving to a public charity so you get better tax breaks than if you give to a private foundation, but also under this new Tax Act it’s become harder to itemize deductions. In 2017, 36 million taxpayers itemized their deductions. Now, it’s only down to 16 million. So, very few people can deduct their charitable gifts. So, you can concentrate your gifts; like if you give 10,000 a year, put 40,000 into a Donor Advised Fund and that way you will be able to itemize your deductions this year. Then in future years, take the standard deduction as the Donor Advised Fund makes a grant.
You were just comparing and contrasting Donor Advised Funds to private foundations. What is the difference?
Well, with the private foundation you actually have to form a separate nonprofit corporation or trust. You have the related costs of maintaining it, filing a tax return and the like. Then, with the private foundation, when you give certain assets like real estate or closely held stock, your tax deduction is usually less than if you give it to a Donor Advised Fund.
Okay. So, when do donors prefer a Donor Advised Fund over a private foundation?
Well, there are probably four main reasons:
- The first is the convenience. You can set one up in a half hour, compared to forming a private foundation and filing paperwork and applying for the tax status.
- Second is the cost savings. You have economies of scale. With the private foundation, you have got to pay for the tax return and do all the administrative costs.
- The third is tax savings, that you can get bigger tax deductions when you donate certain assets like real estate that’s gone up in value or closely held stock.
- Then, there’s the private foundation taxes, and one of them that’s pretty important is the 5 percent payout. Every year a private foundation has to give away 5 percent of its assets.
Well, if you’re going to donate real estate that’s only earning 1 percent — it’s going to take a few years to sell it — you really want a Donor Advised Fund rather than a private foundation because you won’t have that money to pay out.
Are there times when donors would prefer a private foundation over a DAF?
The three main advantages of a private foundation over a Donor Advised Fund are number one, control, number two, control, number three, control – control, control, control — because with a private foundation you control the governing body; you pick the Board of Directors. It’s you and your family. Second, you control the investments. If you think you’re so smart and you got rich through your own investing, you have to give that up with a community foundation or some other organization. And finally, the grants. You pick who’s going to get the grant recipients. If you really like control, a private foundation is very appealing.
But if I had a private foundation, would it be possible for me to actually convert it to a Donor Advised Fund?
Yes, families with private foundations will sometimes terminate them or make grants or distributions to their Donor Advised Fund, and then it’s to save on the cost. So, for very small private foundations, under a hundred thousand dollars, it makes a lot of sense to liquidate them into a Donor Advised Fund.
Why contribute to a Donor Advised Fund at all rather than contributing directly to a given charity?
Well, first is the timing, like this year you are going to win the lottery. This year you are going to sell your business. This year you’ve got the big gift. And with this new tax law, you want to have lots of charitable deductions in one year to get your tax savings. Then you have some time to think about the grants you are going to make. Then you can consult the staff of the charity for worthy recipients and take your time.
That’s great. What kind of assets could I contribute to a Donor Advised Fund?
The most common gifts are cash, stock (especially publicly traded stock and bonds), but Donor Advised Funds can accept gifts of all sorts of things like real estate, stock, closely held business interests, even intellectual property and things that are less liquid.
To wrap up this podcast Chris, tell us again, who should start a Donor Advised Fund?
First, someone who will benefit with this new tax law of concentrating the gifts in one year, the bunching of gifts, and second, someone who wants to be a philanthropist, who wants to have a philanthropic program for themselves or their family and wants to have years of ongoing giving to their communities.
Thank you for teaching us more about Donor Advised Funds.
This podcast was produced by The American College of Trust and Estate Counsel, ACTEC. Listeners, including professionals, should under no circumstances rely upon this information as a substitute for their own research or for obtaining specific legal or tax advice from their own counsel. The material in this podcast is for information purposes only and is not intended to and should not be treated as legal advice or tax advice. The views expressed are those of speakers as of the date noted and not necessarily those of ACTEC or any speaker’s employer or firm. The information, opinions, and recommendations presented in this Podcast are for general information only and any reliance on the information provided in this Podcast is done at your own risk. The entire contents and design of this Podcast, are the property of ACTEC, or used by ACTEC with permission, and are protected under U.S. and international copyright and trademark laws. Except as otherwise provided herein, users of this Podcast may save and use information contained in the Podcast only for personal or other non-commercial, educational purposes. No other use, including, without limitation, reproduction, retransmission or editing, of this Podcast may be made without the prior written permission of The American College of Trust and Estate Counsel.
If you have ideas for a future ACTEC Trust & Estate Talk topic, please contact us at ACTECpodcast@ACTEC.org.
Latest ACTEC Trust and Estate Talk Podcasts
Learn about the risks of using gift and estate tax exemption that could impact the use of the remaining gift and estate tax exemption.
The conclusion of “Truth, Transparency, and the Right of Privacy.” Duncan Osborne shares his views on balancing attorney-client privilege and an individual’s right to privacy.
Pt. 2 of Truth, Transparency, and the Right of Privacy. Duncan Osborne, a chair of the Financial Action Task Force, shares lessons learned from FATF.