taxes

Choosing Between a Private Foundation vs. Donor-Advised Fund

Whether you want control with a private foundation or confidentiality and fewer restrictions with a donor-advised fund, each of these has its own place.

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.

There are two types of private foundations: 1.) operating; and 2.) non-operating. An operating private foundation 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.

 Private FoundationDonor-Advised Fund
Tax deduction limits for cash30% of Adjusted Gross Income60% of Adjusted Gross Income
Tax deduction limits for appreciated securities (e.g. stocks, bonds and mutual funds)20% of Adjusted Gross Income30% of Adjusted Gross Income
Tax deduction limits for real estate and other privately held assets20% of Adjusted Gross Income30% of Adjusted Gross Income
Valuation of cash giftsFair Market ValueFair Market Value
Valuation of appreciated securitiesFair Market ValueFair Market Value
Valuation of real estate and other privately held assetsFair Market ValueLimited to the lower of Fair Market Value or cost basis in the property
Excise tax on investment income1% to 2% annuallyNone

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.

 Private FoundationDonor-Advised Fund
Requirements to set up and operateComplexSimple
Start-up timeCan take several weeks or monthsCan be immediately
Start-up costsCan be substantial (e.g., legal fees, tax filing fees and other fees)None
Ongoing annual expensesCan be substantial (e.g., administrative and investment management fees)Can be minimal (including investment management fees) depending on the sponsoring organization
Annual minimum distributions5% distribution required annuallyAt the discretion of the donor
ReportingRequired annual state and federal tax returnsNone 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.

 Private FoundationDonor-Advised Fund
PrivacyPublic disclosure of contributions and grants in annual tax returns, including trustee names, staff salaries, and investment feesNames of individual donors can be kept private as well as grants
ControlFull control over grant decisions and investmentsCan recommend grants and investments but the sponsor has the legal authority
Administrative responsibilitiesBoard meetings, maintain board minutes, hiring staff, recordkeeping, selecting charities, administer grants, file annual state and federal tax returns, and other responsibilitiesNone besides making periodic grant recommendations
Investment optionsFlexibleCan be limited depending on the sponsoring organization
Allowable grantsIRS qualified charities, direct gifts to individuals (e.g., scholarships) and other charitable intentionsOnly 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.

About the Author

Carlos Dias Jr., Wealth Adviser

Founder and President, Dias Wealth LLC

Carlos Dias Jr. is a financial adviser, public speaker and president of Dias Wealth LLC, in the Orlando, Florida, area, offering strategic financial planning services to business owners, executives, retirees and professional athletes. Carlos is a nationally syndicated columnist for Kiplinger and has contributed, been featured or quoted in over 100 publications, including Forbes, MarketWatch, Bloomberg, CNBC, The Wall Street Journal, U.S. News & World Report, USA Today and several others. He's also been interviewed on various radio and television stations. Carlos is trilingual, fluent in both Portuguese and Spanish.

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