How To Save Taxes With A Donor-Advised Fund

John Temple
Vice Chairman, FPA Board of Directors

What is a DAF?

Donor-advised funds are 501(c)(3) charitable funds that aggregate charitable donations. Most national investing platforms such as Vanguard, Fidelity, and Schwab sponsor DAFs, contributions to which count as charitable deductions when made. While assets contributed to a DAF are no longer owned by the donor, they are set up as the donor’s Charitable Fund, and the donor can advise the DAF how to invest the assets and when and to which charitable causes to make donations. Investment income in the DAF accumulates tax-free, thereby increasing a donor’s charitable firepower. There are no time limits on making donations from the DAF. In addition to DAFs sponsored by financial entities, there are also unaffiliated national DAFs such as the American Endowment Foundation and the National Philanthropic Trust, as well as cause-specific or community DAFs.

Why Have DAFs Become So Popular?

DAFs have long provided tax planning opportunities enabling individuals to aggregate multi-year donations and deduct them in a year in which they expect to have a high tax rate, while still enabling favored charities to receive donations in line with the taxpayers’ originally intended schedule. Charitable donations made in cash can be deducted up to 60% of a taxpayer’s adjusted gross income.

DAFs, however, have gained more prominence as a tax planning tool since the 2017 Tax Cuts and Jobs Act limited State and Local Tax (SALT) tax deductions. This resulted in many taxpayers who had previously itemized deductions to take the standard deduction. Charitable deductions for those taking the standard deduction are limited to just $300 and $600 respectively for single and married taxpayers. Aggregating several years of expected charitable donations and contributing the entire amount to a DAF in one year can enable the taxpayer to itemize deductions in that year while taking the standard deduction in subsequent years. Donations can still be made as intended to the taxpayer’s favorite charities by advising the DAF when and to whom to make the donation. Donations from a DAF are, of course, not deductible.

Another wrinkle worth noting is that the donor can advise the DAF what to do with the funds in the event of the donor’s death. Choices include distributing the assets to one or more charities or specifying a different person to advise the DAF on future donations.

Donating Appreciated Securities Can Save Even More Tax

Whether making a contribution to a DAF or directly to a charity, donating appreciated securities can be especially tax efficient. The full market value of the appreciated securities can be deducted, up to 30% of adjusted gross income, while capital gain is avoided on the appreciation. The DAF also does not incur any capital gain tax liability on subsequent sale of the securities.

While some charities cannot accept securities, DAFs can usually accept publicly-traded securities, which can then be sold, enabling cash donations to be made to the favored charity. Here at the Facial Pain Association, we are pleased to accept donations of cash or securities, whether directly from donors or indirectly through a donor-advised fund.

On a Personal Note…

I retired a few years ago, shortly after joining the FPA Board of Directors. Knowing that I was shortly to lose my earned income and with social security and IRA distributions still several years away, I could foresee my marginal tax rate dropping substantially. To take advantage of this, I set up a DAF with Vanguard Charitable with an amount approximating to what I intended to donate over the following five years, taking the entire deduction in the year of my retirement when my income was high. The savings have far exceeded my expectation, partly because the capping of SALT deductions has meant that I have taken the standard deduction for the last two years which meant I could only take $600 of charitable deductions, and partly because the investment returns at Vanguard Charitable have been so good that the original contributed balance has hardly declined despite two years of donations to FPA and others. I just wish I had contributed appreciated securities, but you cannot think of everything! Finally, please discuss tax saving strategies with your tax advisor before executing them — tax laws change frequently, and I and the FPA cannot provide you with tax advice.

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