With the Tax Cuts and Jobs Act, you’ve read about how charitable planning can provide higher tax savings. But you may be asking yourself if you should set up a private foundation or donor-advised fund. So, which one is the better option? It really depends on a multitude of issues, and we’ll explore the reasons why you may prefer one over the other.
In 2019, the standard deduction is $12,200 for individuals, $18,350 for heads of household, and $24,400 for married couples filing jointly as well as surviving spouses. For a married couple who file jointly, in order to even consider charitable donation, it should be a sizable one that exceeds the standard deduction.
What is a Private Foundation?
A private foundation is a section 501(c)(3) nonprofit organization that isn’t a public charity. It can be set up by an individual, family or corporation and typically involves a large initial donation to get it started. For the most part, donations come primarily from individuals or businesses and are managed by the trustees of the foundation.
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There are two types of private foundations: 1.) operating; and 2.) non-operating. An operating private foundation (opens in new tab) must spend at least 85% of its adjusted net income or its minimum investment return, whichever is less, on its activities. Therefore, most private foundations are non-operating, which means these foundations make grants out of their own assets to other charities instead of their own activities.
What is a Donor-Advised Fund (DAF)?
A donor-advised fund is a separately managed charitable investment account that is operated by a section 501(c)(3) organization, also known as a sponsor or sponsoring organization. You can contribute cash, appreciated securities, real estate and other property and receive an immediate tax deduction. Those assets grow tax-free, and in turn you can make recommendations to any IRS qualified charity, although the sponsoring organization makes the final decision.
Before choosing between a private foundation or donor-advised fund, make sure you distinguish the following three areas between each:
1. Tax considerations
It’s important to know the tax deduction limits for cash, appreciated securities — such as stocks, bonds and mutual funds — real estate and other privately held assets when making a donation. Other aspects include valuation of gifts, and excise taxes on investment income.
| Header Cell - Column 0 | Private Foundation | Donor-Advised Fund |
|---|---|---|
| Tax deduction limits for cash | 30% of Adjusted Gross Income | 60% of Adjusted Gross Income |
| Tax deduction limits for appreciated securities (e.g. stocks, bonds and mutual funds) | 20% of Adjusted Gross Income | 30% of Adjusted Gross Income |
| Tax deduction limits for real estate and other privately held assets | 20% of Adjusted Gross Income | 30% of Adjusted Gross Income |
| Valuation of cash gifts | Fair Market Value | Fair Market Value |
| Valuation of appreciated securities | Fair Market Value | Fair Market Value |
| Valuation of real estate and other privately held assets | Fair Market Value | Limited to the lower of Fair Market Value or cost basis in the property |
| Excise tax on investment income | 1% to 2% annually | None |
2. Expenses
Expenses can vary significantly from a private foundation to donor-advised fund as well as startup costs, time, annual minimum distributions and reporting.
| Header Cell - Column 0 | Private Foundation | Donor-Advised Fund |
|---|---|---|
| Requirements to set up and operate | Complex | Simple |
| Start-up time | Can take several weeks or months | Can be immediately |
| Start-up costs | Can be substantial (e.g., legal fees, tax filing fees and other fees) | None |
| Ongoing annual expenses | Can be substantial (e.g., administrative and investment management fees) | Can be minimal (including investment management fees) depending on the sponsoring organization |
| Annual minimum distributions | 5% distribution required annually | At the discretion of the donor |
| Reporting | Required annual state and federal tax returns | None at account level |
3. Benefits
Depending on whether a private foundation or donor-advised fund, privacy, control, administration, investment options and allowable grants will vary from one to another.
| Header Cell - Column 0 | Private Foundation | Donor-Advised Fund |
|---|---|---|
| Privacy | Public disclosure of contributions and grants in annual tax returns, including trustee names, staff salaries, and investment fees | Names of individual donors can be kept private as well as grants |
| Control | Full control over grant decisions and investments | Can recommend grants and investments but the sponsor has the legal authority |
| Administrative responsibilities | Board meetings, maintain board minutes, hiring staff, recordkeeping, selecting charities, administer grants, file annual state and federal tax returns, and other responsibilities | None besides making periodic grant recommendations |
| Investment options | Flexible | Can be limited depending on the sponsoring organization |
| Allowable grants | IRS qualified charities, direct gifts to individuals (e.g., scholarships) and other charitable intentions | Only IRS qualified charities |
While every donor is different, some may prefer retaining control with a private foundation, whereas others might want to make a donation and not have to worry about the expenses and requirements with a donor-advised fund.
This article was written by and presents the views of our contributing adviser, not the Kiplinger editorial staff. You can check adviser records with the SEC or with FINRA.
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