By Keiter CPAs
Which plan is best for you when considering your charitable legacy?
Many who are considering a lasting charitable legacy have goals and aspirations beyond direct charitable giving to specific organizations. Families are often looking for longer-term giving strategies that help facilitate their overall goals and intentions. Two common charitable giving vehicles that should be considered are Private foundations (PF) and Donor-advised funds (DAFs).
While contributing directly to a specific organization remains an option, contributing funds to a PF or DAF allows you to take a charitable tax deduction in the current year without having to make immediate donations to specific charities. The donor may make a large gift to one of these vehicles in a high-income year and then the funds can be used to support charities over time. This provides you with additional time to decide on recipient charities and/ or control the timing of donations to such organizations as they carry out their mission.
Below is an overview of each vehicle and the key considerations when deciding between a private foundation or a donor-advised fund.
What is a private foundation?
A PF is a charitable organization, typically structured as a trust or corporation and designed to accept donations from an individual or small group of people, such as you and your family.
Benefits of a private foundation
A PF allows the donor to remain in control allowing you to determine the mission, board, how the funds are invested, and how and when the funds are given away. Creating a private foundation may also provide philanthropists with the opportunity to involve others in their charitable efforts by establishing a board of advisors or by hiring someone to manage the foundation on their behalf. Many families set up a private foundation as vehicle for teaching their children about philanthropy and involving them in the charitable donation process. This added level of flexibility and involvement creates additional reporting requirements as the private foundation is a separate legal entity requiring its own income tax filings, including payroll reporting should it have employees.
What is a donor-advised fund?
A DAF is an investment account established and funded by a taxpayer—controlled by a sponsoring organization—usually, a public charity or community foundation—and often managed by an investment firm. A DAF account is not a separate legal entity. The fund accepts tax-deductible contributions from investors, who advise the fund on how their charitable dollars should be spent. For tax purposes, the taxpayer makes a charitable gift in the year in which they contribute to the DAF, not when distributions are made from the DAF to the specific charity.
Benefits of a donor-advised fund
Traditional thinking may lead many to only consider establishing a private foundation to help manage larger and longer-term philanthropic activities. While private foundations are often quite impactful, they may come with high setup and ongoing operational costs. DAFs are a popular alternative which offer many of the same benefits, but generally are less costly to set-up and administer on an annual basis.
Private Foundation vs. Donor Advised Fund: Important Points to Consider
| Set up | Takes time and will incur professional fees as it requires establishing a legal entity | Typically established within a matter of days or less Possible to create a DAF at little to no cost with a minimum initial contribution as low as $5,000 |
| Income tax deduction | Limited to 30% of the donor’s Adjusted Gross Income (AGI) for cash contributions and 20% of AGI for noncash contributions (often donations of appreciated stocks) | Cash contributions to DAFs are tax deductible up to 60% of the donor’s AGI, while noncash contributions are generally deductible up to 30% of AGI |
| Donations | Can receive gifts during a donor’s lifetime or at his/ her passing as a beneficiary of the estate | Can receive gifts during a donor’s lifetime or at his/ her passing as a beneficiary of the estate |
| Option to support charities anonymously | Must publicly disclose the names of donors who give more than $5,000 The name of the PF will be associated to each donation made to other organizations | Even if the DAF bears the owner’s name, the larger sponsoring organization could make any donations in its name and provide anonymity to the DAF Permitted to accept donations privately, so it’s possible for contributors to remain anonymous |
| Investment Management | You and other board members retain full control over the foundation’s investments and distributions (expenses and charitable donations to recipient organizations) | The assets in the DAF will be invested by the sponsoring organization and the investments earnings will add to the value of the DAF account DAF contributions become the sponsor’s property and the donor’s role in managing investments and distributions is strictly advisory. Practically speaking, however, sponsors follow contributors’ advice |
| Expenses | May be significant as you will need to appoint a board, hold periodic meetings, keep minutes, provide tax receipts to donors, file separate tax returns, and incur ongoing legal and accounting costs. These costs are in addition to paying investment fees to manage the assets of the private foundation As a result of the start -up expenses and ongoing costs, it is recommended that the level of assets maintained in the entity be substantial so that such costs are a small portion of the overall benefit derived by the private foundation | DAFs typically charge management and investment fees of around 1% to 2% of your account balance. Such fees will reduce the value of your account |
| Employees | May need to hire staff or engage a third-party administrator for various tasks | The main drawback is that the DAF cannot have its own employees. If the ability to pay others to work for the charitable purpose is a primary concern, the DAF should not be used |
| Taxes | Subject to a Federal excise tax on net investment income (currently 1.39%) Other than the annual excise tax on investment income, the earnings on the investments of the private foundation are exempt from tax | The earnings on the DAF account are not subject to income tax and there is no excise tax on the investment earnings as is the case with a private foundation |
| Annual Distribution Minimum | Must (annually) distribute at least 5% of the total fair market value of its non-charitable use assets | Not subject to required minimum distributions, so investments can grow tax-free indefinitely Note that some DAFs may require periodic donations out of your fund |
| Types of Grants | Typically make grants to other charitable organizations rather than provide direct charitable services themselves The tax code contains penalty provisions that prevent the founders of a private foundation, its board and management from using the assets of the foundation to benefit themselves and not other tax exempt organizations | Distributions from DAFs must be made to public charities Cannot make contributions where any individual receives a benefit from the donation, for example, athletic seating preferences |
| Lifespan | Will terminate when funds are exhausted Can operate in perpetuity | Will terminate when funds are exhausted Can designate a successor advisor(s), so that the DAF does not have to end on the death of the original donor Alternatively, you can name final charitable beneficiaries to receive the remaining assets in the fund at your death |
Many people or families have a strong sense of philanthropic duty and intend to leave a charitable legacy and/ or pass down such traits to future generations. Both a PF and DAF can provide a structure for family or legacy giving. There is much to consider in choosing the best charitable vehicle to accomplish the varied goals.
Keiter has substantial experience in advising families with mutigenerational wealth, executives, and entrepreneurs about private foundations and donor-advised funds. Contact your Keiter Opportunity Advisor | Email | Call: 804.747.0000
About the Author
Keiter CPAs
Keiter CPAs is a certified public accounting firm serving the audit, tax, accounting and consulting needs of businesses and their owners located in Richmond and across Virginia. We focus on serving emerging growth businesses and companies in the financial services, construction, real estate, manufacturing, retail & distribution industries and nonprofits. We also provide business valuations and forensic accounting services, family office services, and inbound international services.
More Insights from Keiter CPAsThe information contained within this article is provided for informational purposes only and is current as of the date published. Online readers are advised not to act upon this information without seeking the service of a professional accountant, as this article is not a substitute for obtaining accounting, tax, or financial advice from a professional accountant.
