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.
| 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.
| 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.
| 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.
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