Thanks-for-Giving – A Guide to using Donor Advised Funds to lower your tax bill under the new tax law
Article Summary:
The 2018 tax law changes raised the standard deduction substantially.
Due to the change, only 14% of taxpayers itemized their deductions in 2018, compared to 31% in years prior.
If you aren’t itemizing deductions, you aren’t getting a tax benefit for your charitable contributions.
Using a ‘Donor Advised Fund’ (DAF) may help to make your charitable contributions deductible again.
Read on for further background on the DAF. A good financial planner can you help you decide if this tool is a good fit.
The Holiday season is once again upon us. Many of us will be traveling long distances to spend quality time with Friends and Family. For some, it’s the best time of year – it’s a time of thanks, a time of reflection, a time to catch up with relatives, a time to relax with those we love. And, most importantly, it is a time for giving.
The month of December has been named ‘National Giving Month’. The biggest on-line global giving campaign of the year, ‘Giving Tuesday’, occurs the Tuesday after Thanksgiving. Studies have shown that up to 31% of annual giving occurs during the month of December. Americans have always been charitably-minded no matter what month it is but there is no mistaking -- this Holiday Spirit stuff really works when it comes to charitable giving!!
Which leads me to a discussion about one of the fastest growing vehicles used to give to charities – the Donor Advised Fund (DAF). Chances are, despite DAFs being around for a number of years, you have probably never heard of them until recently. DAFs have been the talk of the town (for nerds like me) since the new tax laws went into effect in 2018 and for good reason – let me explain….
Changes from the 2018 Tax Cuts and Jobs Act (TCJA)
Prior to the 2018 tax law change, a married couple’s standard deduction was $12,700. For all taxpayers, you are able to deduct the greater of your itemized deductions or your standard deduction on your tax return. Itemized deductions for the most part consist of the state, local and real estate taxes (Taxes) we pay plus any mortgage interest (Interest) we pay plus any charitable contributions (Charity) we make. If these three amounts (Taxes + Interest + Charity) add up to more than your Standard Deduction, you are then able to deduct this larger itemized deduction amount, ultimately saving you tax dollars. According to statistics from the Tax Foundation approximately 31% of taxpayers itemized their deductions prior to 2018.
Beginning in 2018, the new tax law basically doubled the standard deduction for all individuals. A married couple’s standard deduction was increased to $24,000. This increase, along with the fact that the new tax law capped the ‘Taxes’ portion of your itemized deduction calculation at $10,000 (when it used to be unlimited), essentially meant that less individual taxpayers would be itemizing their deductions in the future. This was substantiated when the Tax Foundation recently released their 2018 data which showed that only 14% of taxpayers itemized their deductions last year.
Enter Donor Advised Fund
When it became apparent that this new tax law was going to mean less taxpayers would itemize their deductions, it sent shock waves through the non-profit world. Non-profits were afraid individuals would think twice about giving to charities if they weren’t getting a tax benefit for doing so. One year into the new tax law it seems these fears were warranted. Giving USA estimated that individual giving fell by 3.8% on an inflation-adjusted basis between 2017 and 2018.
DAFs may be non-profits’ saving grace – Here’s why:
They are separate charitable investment accounts you maintain through a qualified custodian such as Vanguard, Fidelity, Schwab, etc.
Initially most custodians have a minimum account opening amount of around $5,000 but no minimum account balance thereafter.
Any amounts contributed into a DAF have been irrevocably earmarked for charity and your actual charitable tax deduction is based on when you make a ‘contribution’ into your DAF, not when you actually ‘grant’ amounts out of your DAF to an actual charity.
You can take however long you wish to donate your DAF account holdings to a charity and this donating process is called making a ‘grant’. Grants can be made in as little as $50 increments and are sent via check to any qualifying charity you designate.
Any amounts that remain in your DAF can be invested in a variety of investment options ranging from conservative to aggressive. If your funds grow while they are in your DAF, you are not taxed on this growth, you just have more funds to grant to a charity.
As long as you have owned a security (ie stock or mutual fund) for > 12 months, you can contribute this security electronically into your DAF instead of contributing cash and you will receive the fair market value of the security as your charitable deduction without having to pay any capital gains tax on its appreciation.
Once you fully understand how the new tax law has affected your ability to use your itemized deductions versus your standard deductions and you understand how DAFs work, it may make sense for you to take a good, hard look at using a DAF to ‘bunch’ your charitable contributions into one tax year on a periodic basis using the following example as a guide.
An Example of Tax Savings by Using a Donor Advised Fund
Let’s assume you are married couple filing jointly and you have $200,000 of taxable income, mortgage interest of $10,000 and you typically give $3,000 a year to charity. Using the left-side of the table below, if you were to continue to consistently give $3,000/year to charity, under the new tax law you would take the standard deduction every single year as it is more than your itemized deductions.
On the right-side of the table we introduce you to the concept of ‘bunching’ your charitable contributions through use of a DAF. You are essentially front-end loading your charitable deduction in order to itemize our deductions in one tax year while taking the standard deduction in the other years while still being able to give a consistent $3,000/year to charity as ‘grants’ out of your DAF. Using a DAF fund in this way helps to maximize your tax deductions over time ($131,000 of deductions versus $120,000), which saved this couple $2,640 in taxes as they are in the 24% Federal tax bracket and yet they gave the exact same amounts to charity over this 5-year period.
As you can see, the DAF is a thing of beauty when it comes to Giving as it allows us to give consistent annual amounts to our most cherished charities and, at the same time, allows us to bunch our charitable deductions into one tax year so we can maximize our tax deductions.
This example doesn’t even take into account further potential savings possible by funding the account with an appreciated asset. By using an investment that has a big gain to fund your DAF, you get a charitable deduction for the value at gifting AND avoid the capital gains tax. It’s a win-win-win.
So as we enter this season of Thanks and this season of Giving – we want you to understand that there is a new, popular way for all of us to be Thanked for Giving and that is through a DAF. Please feel free to reach out to us if you have any questions regarding whether a DAF is right for your situation or not.