Written by Rob Clarfeld for Forbes
Americans are a generous people, giving away more than $410 billion in 2017, according to Giving USA, with more than 70% of that donated by individuals. Most people express their philanthropic desires by writing checks to the various charities that are important to them. Certainly direct giving is easy and convenient, but often lacks tax efficiency or a longer-term strategic focus.
For individuals and families that want their philanthropy to continue for generations or are concerned with income tax minimization efficiency, alternative options to direct giving include setting up a private foundation or contributing to a donor advised fund (DAF). There are positives and negatives to each.
Building a Legacy with a Private Foundation
For those with multigenerational wealth and the desire to leave a lasting legacy, a private foundation offers a lot of benefits. It adds prestige to the family name and can teach future generations the importance of being charitable and contributing to society. A private foundation also gives the donors total control over which qualified charities receive grants. Family setting up a private foundation can control the succession of trustees and board members for as long as the foundation remains in existence.
On the downside, private foundations are more complicated than DAFs. They require time-delaying filings and other paperwork to establish them, and there are upfront legal fees and annual maintenance costs for the required tax filings and recordkeeping. Private foundations also are required by law to distribute a minimum of 5% of their assets annually and must pay an annual excise tax of 1-2% of net investment income. Generally, those opting for private foundations endow them with a significant contribution and have multigenerational charitable intentions.
Let Someone Else Handle the Hassles
Conversely, donor advised funds are established immediately and at no cost, which explains their growing popularity. Most brokerage custodians—Fidelity, Schwab, TD Ameritrade, etc.—can have DAFs set up and running the same day. Once they are established, the fund sponsor handles all administrative functions. The tax benefits from donations to DAFs also are superior to that of private foundations. The limitation on deducting charitable donations (as a percentage of adjusted gross income on one’s tax return) is the same as for direct giving, 60% for cash donations versus 30% for private foundations, and 30% verses 20% for donated securities. Also, there is more privacy around DAFs, compared to private foundations that can be researched in publicly available databases, which often creates a flow of unwanted solicitations. As stated above, DAFs don’t pay an excise tax on investment gains.
A consideration that I’ve found to be more theoretical is that unlike a private foundation, although DAF donors advise on potential grants, the sponsor has the ultimate authority to approve or deny recommendations. There are also restrictions on what types of organizations are eligible for DAF grants.
Bunching of Deductions
The overarching benefit of both private foundations and DAFs is the ability to control the timing of when you receive a tax deduction and when charities receive funds. This can make a big difference in a year when one has an exceptionally high income – large bonus, vesting of restricted company stock, sale of a business, or winning the lottery – when charitable deductions are of greater value, and its beneficial to spread out payments to charities over several years. Both vehicles allow the deduction in the year you gift to the vehicle, while the charities receive the funds in the year you choose. Further, the recently enacted tax law, Tax Cuts and Jobs Act, may make the “bunching” of tax deductions into a single year adventurous for some taxpayers (See: Preserving Tax Benefits For Charitable Contributions)
Whether the desire to do good results in simply writing a check, contributing to a DAF or setting up a private foundation, maximizing the tax benefits of charitable contributions can be complicated and should be discussed with your tax or financial advisor.
ABOUT THE AUTHOR ROB CLARFELD
Rob Clarfeld is founder of Clarfeld Financial Advisors, a leading wealth management firm with offices in Westchester, N.Y., and New York City that provides comprehensive financial and estate planning, sophisticated tax and compliance expertise, and investment management services. Rob is a Certified Public Accountant, Certified Financial Planner® and Personal Financial Specialist with more than 30 years of experience advising financially successful families and family-owned businesses. With a focus on robust and individualized family office platforms, Rob has been Barron’s #1 Independent Wealth Advisor in New York for nine consecutive years, and is the #1-ranked New York independent advisor on the Forbes Top Wealth Advisors list. To find out more, visit: clarfeld.com ** Please Note: Rankings and/or recognition by unaffiliated rating services and/or publications should not be construed by a client or prospective client as a guarantee that he/she will experience a certain level of investment performance.