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Donor Advised Funds

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A client just asked me about terminating his 401k and I think it affects many people, so I am posting my response here (and he is getting free advice from me for this). I answered in sections:

A DAF permits an accelerated upfront charitable tax deduction while enabling you to budget distributions to the charities of your choice. You can get a full tax deduction when appreciated stock is contributed (provided it has been held more than one year) while not having to recognize the gain as capital gain income. Further by using stock, the donor conserves their cash position. You will get your tax deduction in the year of your contribution to the DAV, regardless of how long the funds are retained in the DAF. There is no time limit of when contributions must be made from the DAF. However, there will be no further tax deductions when contributions from the DAF are disbursed to your charity.

Funds contributed to the DAF that are not immediately distributed to the charity will be segregated on the DAF’s records and invested in your choice of designated mutual funds or a money market account until the funds are disbursed. Any gains (or ugh, losses) increase or decrease your balance on a tax-free basis. There is also a small administrative fee charged to your DAF account.

The funds transferred to the DAF cannot be returned to you, nor do you have any rights to the funds. What you can do is make recommendations of a public charity where you want the funds distributed. Usually, the DAF will comply with your wishes; however, before you open the account you should ascertain that they will accept recommendations to the charities you contemplate donating to.

With a DAF there are no tax forms you need to file (except for Form 8283 to report the contribution on your individual return) and there is no type of regulatory compliance actions on your part. When the donations are made to your charity of choice you will not get a tax deduction since you received the deduction up front in the year you contributed to the DAF. However, your charity will receive a letter acknowledging that you are the contributor.

Contributions from the DAF can be made in your or your spouse’s name or any other family member’s name. You can also designate multiple family members that are able to make recommendations. You can make contributions anonymously if you want to stop the flood of solicitations you are now getting, and others can make deductible contributions to your DAF. An estate planning strategy is to transfer a fixed amount of money or specific stock shares from your present IRA into a newly formed IRA with your DAF named as the beneficiary. This will bypass probate and will avoid any income taxes on distributions, and your prearranged family members can carry on with the DAF long after you are gone. You can also determine the name of the DAF.

The best way to utilize a DAF is to donate appreciated securities held for more than twelve months. For those with large concentrated stock positions, this is a method to reduce these holdings. Usually, the DAF will immediately sell all securities contributed to it and you would recommend how it would be invested within the DAF among the mutual funds they designate. A downside to DAFs is a contribution of a very large position in stock since the immediate sale could cause a drop in the price. In those situations, there are other ways to deal with this, but not through the DAF.

This is also beneficial for someone with large accumulated taxable long term gains because they can accelerate what they normally would contribute over the next few or more years and get the upfront deduction. Designations can then be made on your own time table in any amounts you want. Some funds have minimum contribution amounts but these are usually quite low. It is also something that someone that will be retiring in a few years can do to get the deductions while they are in a higher tax bracket and have their contributions continue when they are no longer receiving their salary. For those that itemize their deductions, it might be advisable to bunch their next few year’s contributions into this year with the DAF and then take the standard deduction in the later years. This is an important strategy and something you should discuss with your tax advisor. Also for those on Medicare, donating the appreciated shares rather than selling them would not cause the gain to increase your Adjusted Gross Income which could increase your Medicare premiums.

Some people set up a DAF and use it to encourage their children to make contributions to instill a giving attitude. DAFs are a no cost alternative to setting up a private foundation which is more involved with tax filings, minimum distribution requirements and annual fees. For taxpayers over age 72 that are taking required minimum distributions, making Qualified Charity Distributions (QCD) from your IRA might be a better strategy than the DAF, so also check this with your tax advisor. Please note that QCDs cannot be made to a DAF. They must be made to public charities.

These contributions, like all contributions, have IRS imposed maximum annual deduction amounts. This should be checked with your tax advisor before making the contribution.

There are numerous ways to set up a DAF either with commercial vendors such as the major brokerage firms or with many not-for-profit organizations. A quick search can provide you with sponsors. You can also check with your tax advisor or contact me for a recommendation. There are minimum contributions to start a DAF such as $5,000 but very low minimums to maintain them afterward.

The above is for your information and I suggest you check with your tax advisor before doing anything mentioned here. If you have any business or financial issues you want to discuss please do not hesitate to contact me at emendlowitz@withum.com.

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