DAFs vs. Private Foundations: Choosing the Best Option for You

For those individuals with the financial means and foresight to build a charitable giving strategy, you will find yourself faced with a choice between two primary tools: a donor advised fund or a private foundation.

Which is best is determined by your level of wealth and the amount of control, labor, legal costs and privacy that you desire. This article will look at the pluses and minuses of each.

Donor Advised Fund

A donor advised fund (DAF) is an investment account which can only be used for charitable purposes. The assets that enter within it can never be used for any other purpose than to make grants to nonprofit organizations. The DAF itself is an account that is held and administered by a sponsoring nonprofit organization. Examples of such organizations include community foundations, nonprofit arms of financial institutions, and stand-alone foundations that exist only to be DAF administrators.

The advantages of DAFs include:

• Low Cost/ Low Barrier to Entry: Many DAFs can be opened with no set-up costs nor application fees. Depending upon the sponsoring organization, a fund can be opened for as little $5000-$25,000 for the initial transfer into the fund.

• Tax Advantages: Transfers made into a DAF allows the donor to take an income tax deduction of up to 60% of Adjusted Gross Income (AGI) for gifts of cash, and up to 30% of AGI for appreciated assets such as stock.

• Privacy: Grants made out of a donor advised fund can be given anonymously, with no public record of the grant.

• Administrative Ease: The sponsoring organization handles all IRS reporting and filings.

Disadvantages of DAFs include:

• Limited Recipients: Grants made out of DAFs are usually restricted only to 501(c) (3) public charities.

• Advisory Restrictions: As indicated within their name, the donor only has

“advisory “ responsibilities over their fund. Since they no longer have legal ownership of the assets they that they donated into the fund, the sponsoring organization has final legal control over grants and where they go to. Although this is not normally an issue, it is important for the donor to understand what restrictions may exist.  As an example, a donor may desire to make a grant toward disaster relief efforts in a foreign country. However, their DAF at the local community foundation in their hometown may have restrictions from grants being used for charitable efforts that are not considered “local.”

Private Foundation

A private foundation is a specialized type on nonprofit organization that is controlled and funded by a single source. As a legal entity, it usually is a corporation or trust and therefore has an administrative board that oversees its operation. The board usually consists of the donor and their family members.

Advantages of private foundations include:

• Total Control: The board of the foundation  have complete control over grants, investment holdings, and board seats.

• Grant Flexibility: Although some IRS restrictions exist, foundations can make grants to individuals in need, overseas organizations, traditional nonprofits, or endow scholarships.

• Family Employment: Foundations can hire family members and pay a reasonable salary for foundation work, such as reviewing grant applications or vetting charities.

Disadvantages of private foundations include:

• High Costs/High Barrier to Entry: Prevailing opinion among wealth advisors is that an initial gift of $5 million or greater is the necessary starting point in which the creation of a private foundation makes sense. Initial legal expenses are estimated to cost $5000 - $15,000 to create a foundation, with costs rising higher depending upon complexity. Ongoing annual tax preparation and tax filing costs could be $3500 to $10,000 to start.

• Tax Impact: Transfers made into a private foundation allows the donor to take an income tax deduction of up to 30% of Adjusted Gross Income (AGI) for gifts of cash, and up to 20% of AGI for appreciated assets such as stock. This is not as advantageous as the limits for DAFs.

• High Maintenance: The private foundation has to file an annual Form 990-PF as well as endure ongoing administrative tasks and costs.

• Public Record: The names of all donors who paid into the foundation, the board members, and grants made are a matter of public record within the Form 990-PF.

• Payout Requirements: Private foundations must payout at least 5% of the foundation assets annually in grants.

Both?

Although it may seem redundant, in some cases it may make sense for a donor to have both a DAF and a private foundation. Some of the reasons for this include:

• Satisfying the 5% Payout: You may have difficulty in determining what causes you want to make grants toward. Your private foundation can make the 5% annual payout to your DAF, allowing you to meet the IRS requirement while giving you time to decide on what charitable grants you want to make.

• Privacy vs Publicity: Although grants made from a private foundation are public record, you can use grants from your DAF to causes that might be considered sensitive or controversial.

• Complex Assets and Tax Advantages:  Generally speaking, complex assets like real estate or private stock gifted into a DAF provide a deduction to the donor at fair market value, whereby those same assets donated into a private foundation are deducted at a cost basis. By segregating complex assets from simple assets( such as cash or public stock), a donor can gain greater tax advantages by using both tools.

Conclusion

Deciding on choosing between a private foundation or a DAF can be a complicated and confusing process. At Generosity Nexus, we have helped numerous donors decide on the best path for them. Working alongside accountants, tax advisors, and attorneys, we can help you navigate the best route for you, your wealth, and the giving you want to do.

Don’t hesitate to schedule an appointment to learn more about how we can help you.