Most people think of charitable contributions as standard gifts to public charitable, religious or educational organizations. However, as you go up the income level brackets, there are more diverse options for charitable contributions and the mechanisms to implement them, such as gifting through either a private foundation (PF) or a donor-advised fund (DAF). In either of these cases, you receive immediate tax benefits while establishing a running source of charitable contributions and delaying distributions of assets to any specific charity.
- Note: This section of tax law is quite complex – before taking any action, make sure you have consulted a qualified tax lawyer and/or financial planner to make sure which course of action is best for your specific case. Neither this article, nor any article, can substitute for sound, personalized legal advice.
Typically, the income tax benefit from a charitable donation is to reduce the taxable income of the donor, making the donations more attractive for higher income taxpayers. By way of illustration, for those in the highest 39.6% federal income tax bracket (as of 2014), every $1,000 in charitable contributions will reduce their tax liability by $396; the same $1,000 contribution from those in the 28% tax bracket reduces their tax liability by $280.
Limits exist on the collective tax benefit of charitable contributions. The upper deduction limit is 50% of AGI (adjusted gross income), and depending on the type of contribution and the receiving organization, the maximum deduction may be limited further.
The following is a comparison of direct gifts vs. two other common methods:
- Direct Gifts to Charity – One-off contributions where you are donating an asset and reaping the tax benefit, with no further dealings with the asset. A contribution that is larger than your allowable AGI limit gives you no further tax benefit. Donating a car, boat or piece of real estate would exemplify this type of charitable giving.
- Private, Non-Operating Foundation (PF) – In this case you are setting up a corporation or charitable trust to assign and distribute your charitable contributions. You can retain control of the distribution of those assets (typically as grants), and your PF is required to annually donate a minimum of 5% of its assets to charity. Limits are lower (30% of AGI for cash and 20% for securities). A typical PF would open with $1 million or more in assets because of administrative costs. Grants and awards are public records for a PF. IRS restrictions are greater on a PF – and many states require them to provide annual audits — but the tradeoff is enhanced control over your assets.
- Donor-Advised Funds (DAF) – In this case, you are contributing to a public charity through the DAF. "Donor-Advised" means exactly that – you advise administrators and make recommendations on grant recipients and amounts, but do not control the final distribution. Generally, there are no minimum requirements for yearly charitable donations, but some periodic donations are required. Limits are higher (50% of AGI for cash and 30% for securities). A typical DAF opens with at least $25,000 in assets. Grants may be made anonymously.
Essentially, through PFs and DAFs you are able to maximize and perpetuate your tax benefits while at least having some say in the destination of the assets (control for PFs and advisement for DAFs). You are giving up the simplicity of the direct gift for the benefit of extended tax benefits and the detriments of administrative costs, potential administrative headaches, and limited control over the assets (depending on which path you take). If you think this may be a viable path for your charitable contributions, check with your financial advisors/accountants/tax attorneys before proceeding to see how you (and your potential gift recipients) may benefit the most.