Donor-Advised Funds: Tax Benefits for Givers
Donor-Advised Funds’ tax benefits are widely known and well documented, and are one reason why the popularity of DAFs has surged in recent years. However, how do DAFs actually work, and what tax benefits do they create? Let’s get into the nitty-gritty.
How DAFs Work
A DAF allows a donor to contribute a sum of money into an account held with a sponsoring 501(c)3 nonprofit organization, such as a public foundation, and take an immediate tax deduction in that tax year.
One of the benefits of Donor-Advised Funds is that donors can then take their time in determining when and where to grant those funds to recipient charities. This ties to the key Donor-Advised Funds tax benefit – it allows a donor to disaggregate their decision to optimize their tax deduction from their decision about which charities to support and how. (However, note that this charitable giving tax deduction has also opened DAFs up to legitimate criticism that they serve primarily as a tax avoidance vehicle, and only secondarily as an effective tool for philanthropy. See here for more.)
DAFs also provide donors the ability to donate non-cash assets such as appreciated stock, real estate, and collectibles such as art – all as a form of charitable donation tax credit. With thoughtful and well-advised planning, donors can reap the Donor-Advised Funds tax benefits while simultaneously increasing the amount they contribute to charity by utilizing these non-cash donations.
A Typical DAF Scenario
Here’s how tax deductions for contributions to Donor Advised Fund work:
If a donor has held an asset such as a stock for more than one year, the donor can contribute that stock to their DAF. The sponsoring foundation that controls the DAF then liquidates that asset (sells the stock), making the full value of the sales proceeds available for that donor to recommend to a charity.
By taking this approach, the donor has avoided paying the entirety of their capital gains tax obligation – which is either 15% or 20% at the time of this writing, depending on the donor’s income level.
Even better, the donor is able to deduct the full fair market value of the asset at the time of transfer into the DAF, significantly reducing taxable income.
Let’s look at the math.
Let’s imagine a donor, we’ll call him Phil Anthropy, bought 100 shares of Apple stock at $5 (don’t you wish you bought Apple for that price now!). This gives Phil a cost basis of $500 for that purchase. If five years later Apple is now worth $50 per share, Phil now owns $5,000 worth of Apple.
Now imagine it’s the end of the year and Phil wants to make a $5,000 donation to his favorite charity. If he doesn’t have the cash, Phil’s first option is to sell his Apple stock for $5,000. When he does this he’ll immediately incur a capital gains tax on his appreciated value – which is $4,500 ($5,000 current value minus the $500 cost basis). If Phil’s capital gains tax rate is 15%, his capital gains tax bill will be $675. It also means that Phil only has $4,500 to give to charity!
The Math of DAF
Next, let’s assume that Phil has a Groundswell account, which is powered by a Donor-Advised Fund. In this scenario, Phil can contact Groundswell to transfer his Apple stock directly into his DAF. Once received, Groundswell sells the position for $5,000 and puts that cash in Phil’s account. Phil then recommends a grant to his favorite charity for the full $5,000. In Scenario 2, Phil pays zero capital gains taxes and is able to deduct the full fair market value of the stock – $5,000 – off his income taxes. That’s a $500 higher deduction than scenario 1 ($5,000 vs. $4,500).
As you can see, Scenario 2 both gives more money to charity and saves nearly twice as much money in taxes. We enjoy the usual Donor Advised Funds tax benefits – and we do more good.
But there is actually a third scenario, and in this scenario the donor gets the best possible outcome: they still give a significant sum to charity and they pay zero taxes. In Scenario 3, a donor works for a company that has implemented a modern day, decentralized approach to its corporate philanthropy.
DAFs & Philanthropy-as-a-Service
With this Scenario 3, a company has chosen to make charitable giving a component of its total compensation or total rewards approach. In this scenario, Acme Corporation understands that its employees, like Phil, are likely already giving a portion of their take-home pay to charitable causes.
Knowing this, Acme Corporation has decided to implement a Philanthropy-as-a-Service solution, like Groundswell, to decentralize corporate giving and provide Phil with an annual charitable giving allowance. Using Groundswell, Acme deposits $5,000 annually directly into Phil’s Groundswell account, which Phil can then direct to the charity of his choice.
The Donor-Advised Fund tax benefits here are astounding. Because the $5,000 is deposited directly into Phil’s DAF – and is never received by Phil as actual income – Phil never has to pay payroll taxes on the funds. The US Federal Government assesses payroll taxes on all earners, and some states pile on additional tax requirements. Current federal payroll taxes for individuals are 7.65% (6.2% for Social Security and 1.45% for Medicare). This means that Phil isn’t responsible for paying the $382.50 in payroll taxes that would have been automatically withheld from his paycheck.
Here, Acme Corporation gets the charitable tax deduction because the contribution to Phil’s Groundswell account qualifies as a contribution to a 501(c)3 public charity, while Phil gets to feel great about sending a big donation to his favorite cause.
Leveraging DAFs, the Groundswell Way
To summarize:
- The key Donor-Advised Fund tax benefit is providing donors a simple, tax-advantaged vehicle to streamline their charitable giving and ensure their deductions are fully accounted for
- Donor-Advised Funds offer incredible opportunities to contribute non-cash assets such as publicly traded equities, creating increased tax advantages for the donor and extra revenue for the nonprofit
- Companies that choose to decentralize their philanthropy can provide employees with a significant financial benefit by contributing funds directly into an employee-held DAF, allowing the company to take the tax write-off and the employee to still make meaningful donations to their favorite charities
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