Whether you donate your time, money, or possessions, you’ll likely experience positive emotional and financial benefits by giving to others.
Along with wanting to make a difference in other people’s lives, you also want to give as efficiently as possible, especially as it impacts your taxes. Tax benefits for donations were put into place by the government to encourage support of various forms of non-profit organizations, so it’s wise to use those benefits.
We’ll take a closer look at the donor-advised fund (DAF), a particular donation strategy that can enrich your giving life while helping others.
The DAF gives you immediate tax benefits even if your distribution comes out later and goes in various directions. When you put money into the fund, you can count it as an immediate deduction, although the money might stay in the fund for years and appreciate. Plus, the fund’s growth is tax-free.
With a DAF, you can donate more funds later while getting a tax write-off now. If you were to give a private foundation money, you would incur a 1 to 2% tax on any growth. No capital gains tax applies to a DAF. Additionally, as these types of funds evolve over time, their custodians become more skilled in investing and growing the money on your behalf.
Because of the nature of DAFs, financial planning is key. We use a couple of methods most often for our clients’ philanthropic efforts.
Method One: Bumper-Crop Year
If you’re in a profession where your annual income can fluctuate, such as a salesperson, rancher, real estate agent, loan officer, etc., you might have some years where your salary spikes. Or something happens that puts you into a higher tax bracket, like selling your business or a piece of property.
When you have a “bumper crop” year, the additional income feels great but owing higher taxes doesn’t. That’s when a DAF can come into play. A DAF allows you to reduce your tax footprint now while putting away your donations for the following year.
Here’s an example: You donate monthly to a homeless shelter and you know how much that donation will be. With a DAF, you might put two years’ worth of homeless shelter donations into your DAF, take the tax break now, and give the shelter monthly donations as you had planned to do.
With the bumper crop year method, your salary spike is mitigated, your tax footprint is reduced, and the next years’ worth of homeless shelter donations are already set aside.
Method Two: Bundle of Joy
With the standard tax deduction increasing to $24,000 for most families, it isn’t as helpful as before to itemize your tax return, unless you donate a good bit to charities. That’s where bundling comes into play.
For instance, if you normally donate $10,000 each year, you could double that donation to $20,000 to also include donations for the following year, as long as you have the available cash. By putting $20,000 into the DAF, your itemized deductions will be over the annual tax limit and your tax footprint will be reduced for that year.
As with the Bumper Crop Year method, you can put that money into your DAF now and experience immediate tax relief, and then over the next two years you can distribute the money to any charitable organization of your choosing.
Your Charity Assistant
Your DAF acts as your charity assistant. Most likely you won’t have the time or energy for tasks related to your DAF so the sponsor who is in charge of your DAF can help.
Sponsors, which are 501(c)(3) organizations that invest the donations and manage the accounts, can range from small to large. They include everything from large, commercial warehouses with charitable arms involved with thousands of nonprofits to nonprofits supporting one specific cause.
The details of how a fund will be distributed are managed legally by your sponsor. Sponsors perform their due diligence by making sure any nonprofits you’re engaged with are in good standing with the IRS and they ensure those nonprofits give as much as possible directly to their cause.
Family Giving Strategy
A DAF can support you and your family in finding the right organizations that fit your giving profile. With a DAF, you’ll have time and opportunity to learn what works best for your family’s values.
While you’re discovering the nonprofits that work best for your giving profile,the DAF will hold and grow your money. The DAF can also house your funds while a charity grows and develops. For instance, if you are passionate about a specific cause, you can put your donations into a DAF while a new nonprofit addressing that cause is being established. When the nonprofit is up and running, your money can then go to it.
Rules and regulations govern DAFs, so there are a few things to keep in mind.
First, a DAF is considered irrevocable, so you cannot take back any donations.
Second, the name includes the words “donor-advised,” which means you have “advisory privileges” to state your preferences on what happens with your donation, but it is not legally enforceable.
Third, because the tax benefit occurs when the money goes into the DAF account, you can cannot deduct the donation again later when the distribution occurs.
Generations of Giving
Your family can get involved in your DAF, bringing you closer together and ensuring everyone is on board with your giving strategy. As a family, you might want to support an institution of higher learning, a hospital system that has served you, or a religious institution.
A DAF is a great way to indoctrinate future generations into thinking about giving. As an example, grandparents might fund a DAF and then allow their children or grandchildren to share presentations on potential nonprofits. Family members might vote and award the best presented nonprofit with $20,000 while other nonprofits get smaller donations.
Having a giving strategy for yourself and/or your family is a wonderful way to enrich your life and the lives of others. With a DAF, you can employ some methods to also take tax advantages. Bradley Wealth looks forward to working with you to determine the most efficient way for you to donate money and use a DAF as part of your financial plan. Equally important, we’re happy to help you help the organizations doing the work you support.