If you decide to use some of your wealth to make the world around you a better place, then you must also decide on a vehicle for making your charitable donations. The most common method consists of deciding how much you want to donate in a given year, selecting the charities that are important to you, and then contributing the funds to those charities. However, there are two options that may be better for you if want more flexibility in how the funds are used, or if you have a longer time horizon than one year. Your options are to:
- Establish a Donor-Advised Fund
- Establish a Private Foundation
Both options would allow you to donate to causes that are important to you. However, it is important to see the differences between all of the vehicles for charitable giving in order to determine which option is best for you.
A Donor-Advised Fund
A donor-advised fund is a charitable option between direct annual charitable giving and a private foundation. Generally, a donor-advised fund is a separately identified account that is maintained and operated by a section 501(c)(3) organization, commonly called a sponsoring organization. Sponsoring organizations often include local community foundations and financial services firms’ charitable foundations. Each donor-advised account is composed of contributions made by individual donors. Once the donor makes the contribution, the organization has legal control over it. However, the donor, or the donor’s representative, retains advisory privileges with respect to the distribution of funds and the investment of assets in the account.
Donor-advised funds could best be described as a “waiting room” for charitable donations, as the money you donate does not go directly to the charitable organization. Once the donation is made to the fund, it cannot be returned to the donor—it then technically belongs to the donor-advised fund. In return for donating, you receive an immediate deduction on your taxes for the amount you have “donated” by depositing into the fund. When you are ready, you advise the supporting organization to disburse funds to the cause of your choosing.
There are several reasons why a donor-advised fund could be a better choice than giving donations directly to a charity. A donor-advised fund could be very valuable to a donor that wants to take a tax deduction without having selected a charity to distribute the money to yet. The donor can take time to decide the charity, while also allowing the money to grow in the account before distributing to charities. Donor-advised funds also offer streamlined recordkeeping because the sponsoring organization handles administrative reporting and other functions.
A Private Foundation
A private foundation is a not-for-profit charitable organization that is typically established by an individual, family, or corporation in order to support charitable activities. The Bill & Melinda Gates Foundation is a well-known example. A board of directors or trustees oversees a private foundation and is responsible for receiving charitable contributions, managing and investing charitable assets, and making grants. They are also responsible for filing tax returns and other administrative reporting requirements. In other words, a private foundation is a charitable organization that is completely set up and managed by the family or individual that established it.
Establishing a private foundation can create a legacy beyond your lifetime and allow family members to get involved by serving as members of the board. In addition, with full control over grant making, a private foundation can support organizations other than 501(c)(3) public charities. By following IRS procedures, donors can make grants to charitable programs undertaken by individuals, scholarship programs, and other entities, making a private foundation one of the most flexible charitable vehicles when it comes to supporting certain types of giving.
Donors thinking about establishing a private foundation should consider several factors before making this significant financial and legal commitment. If you want to go down this road, you will need to immerse yourself in the foundation’s granting strategy, as well as help to operate the foundation, by hiring staff and investment managers, managing grant making, and fulfilling all reporting requirements.
Differences Between a Donor-Advised Fund and a Private Foundation
There are several differences between Donor-Advised Funds and Private Foundations in the way tax deductions apply, the types of activities that the money can be donated to, and the restrictions on when the money must be disbursed. The following table contains a few of these differences.
|Donor-Advised Fund||Private Foundation|
|What can grants be made to?||Grants can be made to charitable organizations that are tax-exempt under Internal Revenue Code (IRC) Section 501(c)(3) and public charities under IRS Section 509(a). Grants can be made to private operating foundations (foundations supporting things like museums). Grants cannot be made to private non-operating foundations.||Grants can be made to charitable programs undertaken by individuals, scholarship programs, and other entities, in addition to tax-exempt Internal Revenue Code Section 501(c)(3) and public charities.|
|How they are tax-exempt||Shares the public charity tax exempt status of the sponsoring organization.||You must apply for private foundation tax exempt status from the IRS.|
|Charitable deductions for cash gifts||Tax deduction up to 50% of adjusted gross income.||Tax deduction limited to 30% of adjusted gross income.|
|Charitable deductions for appreciated property||Tax deduction available for up to full market value. Tax deduction available up to 30% of adjusted gross income.||Tax deduction up to 20% of AGI for appreciated securities. Other types of assets, such as real estate, can be donated to the foundation, but are subject to limitations. Tax deduction is limited to donor’s cost basis in some cases.|
|Payout Requirements||No minimum or maximum grant payout requirements for the fund.||Must pay out at least 5% of the assets’ value regardless of annual income annually for charitable purposes.|
|Anonymity||You can be totally anonymous when making grants from a donor-advised fund.||A private foundation’s filings are public information.|
In conclusion, Donor-Advised Funds, Private Foundations, and directly donating to charity all give you the chance to give back and donate to a charitable foundation you feel passionately about.
A Donor-Advised Fund requires less participation and involvement in the operation of the fund, as the sponsoring organization generally takes care of all the administrative and fiduciary work. A Private Foundation, on the other hand, must be established with the ability to perform all the tasks related to running the organization.
In addition, Private Foundations typically cost significantly more money to establish than a donor-advised fund, though you have much more flexibility in which organizations can receive your support.
-Peter Burnham, Senior Wealth Adviser, Surevest Private Wealth