Donor-advised funds and private foundations offer two ways to financially support causes while gaining valuable tax deductions. Each permits donations of non-cash donations that may include securities, IRA assets, real estate, annuities and life insurance. Donor-advised funds can allow for larger tax-deductible contributions and tax-free growth of invested funds. A financial advisor can help you determine if donating to one of these funds is a good idea for your financial plan.
Donor-Advised Fund Basics
To establish a donor-advised fund, a family or individual makes an irrevocable gift to a special account. The gift can consist of cash, securities, real estate and other assets. The donor’s gift can provide a large one-time tax deduction applied to current income. However, the deduction for a cash gift can’t be more than 60% of the donor’s adjusted gross income. The deduction for a donation of other appreciated assets is limited to no more than 30% of the donor’s adjusted gross income.
Funds in the donor-advised fund can be gifted to support IRS-qualified 501(c)3 charities. While the original gift to the fund is irrevocable, the donor can suggest how funds will be used and which charities to support. Donor-advised funds provide complete privacy, as the identity of the donor does not have to be disclosed.
Investments made with funds in the donor-advised fund can grow without incurring any federal income tax. And there is no requirement for any funds to be distributed as grants to charities. Money can stay in the fund, growing tax-free and later be left to heirs. Donor-advised funds can be set up quickly and easily and with little expense.
Private Foundation Basics
A private foundation is a non-profit, non-governmental organization created to support charitable causes. Funds to establish the foundation can come from an individual, family or corporation. In addition to making cash donations to the foundation, donors can contribute securities, real estate and other non-cash assets.
When donating assets to fund the foundation, the donor can create a tax deduction to apply against current income. The tax deduction is limited to 30% of the donor’s adjusted gross income for cash gifts. Gifts of long-term appreciated securities can be deducted up to 20 percent of adjusted gross income.
Investments made with funds in a private foundation are not subject to federal income tax. However, the foundation must pay a 1.39% annual federal excise tax on net income from its investments.
Comparing Donor-Advised Funds and Private Foundations
Here’s a head-to-head comparison of some of the key features of donor-advised funds and private foundations:
Comparing Donor-Advised Funds and Private Foundations
|Feature||Donor-Advised Fund||Private Foundation|
|Tax deductions for donations||Limited to 60% of adjusted gross income for cash, 30% for other assets held over a year||Limited to 30% of adjusted gross income for cash gifts or 20% of adjusted gross income for publicly traded securities|
|Tax treatment of investment earnings||No federal income tax||Federal excise tax of 1.39% of net investment income|
|Debt-to-income ratio (DTI)||Typically less than 36%||Less than 43%|
|Types of organizations supported||Only IRS-qualified public charities||Individuals and organizations if support has a charitable purpose|
|Privacy||Support can be provided anonymously||Public filings identify foundation owners|
|Costs||Small initial setup cost and few ongoing costs||Significant costs for setup and regular operation|
|Required annual distribution||No required distribution||Minimum 5% annual distribution from the foundation|
The 5% that private foundations must hand out each year can be in the form of grants, scholarships or other charitable distributions. However, they have considerable flexibility in the causes they can support. They are not limited to federally recognized 501(c)3 public charities but can support individuals and other organizations and even fund their own charitable operations as long as the gift supports a charitable cause.
Charitable foundations are managed by a board of directors that decides how to distribute the funds. However, the foundation can employ family members. Setting up a charitable foundation requires specialized legal and accounting assistance and the ongoing costs of running a charitable foundation can be significant as well.
Donor-advised funds and private foundations can be used to implement individual or family charitable objectives. Donor-advised funds offer more privacy and investment income grows tax-free. Charitable foundations are not limited to supporting public charities and provide founders with greater flexibility.
Tips for Donating
- A financial advisor can help you evaluate how donor-advised funds and private foundations fit your own goals. Finding the right financial advisor that fits your needs doesn’t have to be hard. SmartAsset’s free tool matches you with financial advisors who serve your area. If you’re ready to be matched with advisors that will help you achieve your financial goals, get started now.
- You can use SmartAsset’s free federal income tax calculator to see how much federal income tax you will owe. This can help you evaluate the financial benefits of making deductible contributions to charity.
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