We frequently consult with clients who inquire about making charitable contributions, but they are unsure how they wish to allocate their contributions. Many clients approach us with a tax situation which presents an opportunity to make a charitable gift, but the client may not have a clear idea as to which charities are important to them now and which charities may be important to them in the future.
Donor-advised funds (“DAFs”) may be the answer. DAFs became popular after the 2006 Pension Reform Act included guidance as to how DAFs may be managed. DAFs are private funds that are administered by a third party that manages charitable donations on behalf of an individual, family or organization. The administrator may be a brokerage company, such as Vanguard Charitable and Fidelity Charitable Services, or it may be a community foundation such as Community Foundation of Broward in Florida and the Community Foundation of New Jersey.
After a donor establishes a fund with an administrator, the donor or another person specified by the donor, retains the ability to request how the funds will be allocated to charities. A trustee, which is a person or corporation that is appointed to oversee the management and distribution of the fund, is not required to honor the donor’s requests, but the trustee will generally do so. Contributions of appreciated assets do not result in the imposition of income taxes or capital gains taxes. The contributed assets will also continue to grow tax free. Contributing an asset to a DAF removes the asset from the donor’s taxable gross estate.
A DAF is similar to a private foundation, in that a donor relies upon an administrator to manage the investments. The donor may recommend the disposition of the funds to charities; however, it is important that the administrator retains legal control of the assets to ensure that the donation is deemed a completed gift, which entitles the donor to a charitable deduction. It is also imperative that a taxable distribution is not created from DAFs, as a 20 percent excise tax on the amount of the distribution is imposed on the fund sponsor and a 5 percent tax is imposed on the fund manager who agreed to the distribution knowing it was a taxable distribution. A taxable distribution disperses to (i) a natural person or (ii) any other person if the distribution is not for a charitable purpose.
Generally, a donor is better served by contributing assets that are appreciated, rather than selling capital assets and using after-tax dollars to fund DAFs, but appreciated assets are subject to a lower ceiling on the amount of annual itemized deductions. DAFs afford donors with the ability to derive immediate tax benefits, both from an income and transfer tax perspective. A donor may also select a charity or a group of charities to receive the funds immediately. However, contributions to DAFs are irrevocable. Potential donors must properly plan their gifts before making a contribution to DAFs, and should seek the advice of financial and tax professionals before doing so.
This article is the first of a multi-part series that the authors prepared regarding charitable giving.
Michael Salad is an attorney in Cooper Levenson’s Business & Tax and Cyber Risk Management practice groups. He concentrates his practice on estate planning, business transactions, mergers and acquisitions, tax matters and cyber risk management. Michael holds an LL.M. in Estate Planning and Elder Law. Michael is licensed to practice law in New Jersey, Florida and the District of Columbia. Michael may be reached at (609) 572-7616 or (954) 889-1850 and via e-mail at firstname.lastname@example.org.
Jarad Stiles is a member of Cooper Levenson’s Business and Tax and Estate Practice Groups. He focuses on estate and corporate tax planning, business succession planning, administration, tax litigation, elder law, and related matters. Jarad holds an LL.M. in Taxation. Jarad is licensed to practice in New Jersey, New York, and the United States Tax Court. Jarad may be reached at (856) 857-5994 and via e-mail at email@example.com.