Tax Saving Super Hero: The Powerful Tax Advantages of DAFs

Donor advised funds (DAFs) are one of the leading charitable giving tools today. They provide simplicity in set-up and make the process of contributing gifts into the DAF and making grants out to charities easy.

One of the main advantages of DAFs ( and the likely reason they have become so popular over the last 10 years) is their tax saving prowess.

DAFs provide a powerful variety of tax advantages

Immediate Income Tax Deduction

When a donor contributes into a DAF, they are able to earn an income tax deduction at the moment of the contribution. Since a DAF is created and administered by a public charity (known as a sponsor), the deduction is earned upfront, not at the time that the grant is made to a charity.

Your contribution of cash is limited up to 60% of the value of your adjusted gross income (AGI). So as example, if your AGI is $200,000, and you contribute $150,000 in cash to a DAF, you can only deduct  $120,000 (60% of $200,000 ) in that tax year.

If you were to contribute long-term appreciated assets ( i.e. stock held longer than year) , your deduction is limited to 30% of your AGI.

Carry-Over Provision

Any amount that exceeds the AGI limit in the current year can be carried forward 5 subsequent tax years. This means that the donor doesn’t lose the deduction, they just are able to use it over time.

If we review the prior example, the donor was limited to deducting only $120,000 of their $150,000 cash gift in the tax year. However, they could carry-over the remaining $30,000 deduction( provided that their AGI was still $200,000 or greater) into the following year, thereby gaining the maximum tax advantage available.

Zero Capital Gains Tax on Appreciated Assets

A capital gains tax is a tax on a profit you earn when you sell an investment. The sale is known as a taxable event. When you donate an appreciated asset directly into a donor advised fund, you are able to avoid that capital gains tax. You have transferred the assets into the DAF. The transfer is not a sale, and therefore not considered a taxable event.

For those assets that may not have a clear sales value, such as real estate or closely held stocks (C-corp, S-corp shares), the value of the appreciated assets is based on the Fair Market Value (FMV).

A FMV is the price that a willing buyer and willing seller would exchange for an asset. Neither party is under compulsion to buy or sell, and both parties have a reasonable knowledge of relevant facts. In many instances, the guidance of an expert is needed to help determine the FMV.

“Bunching” Contributions to Maximize Itemizing

Charitable bunching (also known “bundling” or “stacking”) is a tax strategy that involves consolidating multiple years' worth of charitable contributions into a single tax year to maximize the tax benefit.

This strategy is primarily used by donors whose total annual itemized deductions are close to, but do not consistently exceed, the Standard Deduction amount. Since the passage of the Tax Cuts and Jobs Act (TCJA) in 2017, the standard deduction has nearly doubled, meaning far fewer Americans have enough deductible expenses (mortgage interest, state and local taxes, and charitable donations) to benefit from itemizing their deductions.

• If your itemized deductions are less than the standard deduction, you take the standard deduction. Your charitable gifts do not provide any additional tax savings.

• If your itemized deductions are greater than the standard deduction, you itemize. You get to deduct the entire amount, leading to greater tax savings.

The goal of bunching is to strategically alternate between itemizing and taking the standard deduction over a period of years to increase your total deductions over time. A donor advised fund becomes the ideal tool in being able to engage in charitable bunching while being able to provide consistent granting to your chosen causes.

Tax-Free Investment Growth

The asset value within the DAF can continue to grow tax-free, providing more money to be granted out to charity.

Estate & Gift Tax Reduction

The asset value within a DAF is removed from the taxable estate of the donor. In the case of a gift tax, normally there would be a tax liability incurred to the donor. However, by making a transfer of assets into a DAF, such gift tax is avoided.

Conclusion

Opening a DAF is easy. However, gaining all the advantages that are available can require additional expertise.

Existing at the  intersection of charitable giving and smart tax planning, Generosity Nexus offers years of insight. We can help guide a donor in the specifics of how to align their giving in ways that enjoy the full tax saving benefits that donor advised funds can offer.

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