Donor Advised Funds – Income Taxes—Part II

Donor Advised Funds

Our most recent posting covered two capital gains strategies that can result in income tax savings. Today, we will address Donor Advised Funds (DAF’s). A Donor Advised Fund is a charitable giving vehicle that has enjoyed increasing popularity in recent years, especially with the passage of the Tax Cut and Jobs Act of 2017.  To participate in a donor advised fund, a donating individual opens an account and contributes cash, securities or other financial instruments. The total contribution amount can be claimed as an itemized deduction in the tax year in which the contributions are made. DAF’s can be opened at a variety of sponsoring organizations such as Vanguard Charitable, Fidelity Charitable, the American Endowment Foundation, among others. Once the account has been established and funded, the donor takes on the role of advisor to the DAF. The donor/advisor directs the sponsor to make distributions in the form of cash gifts to eligible 501(C)3 charities. These charitable directives do not have to take place in the tax year the contribution was made; rather, they can be made in the future at the donor/advisor’s discretion.

The Tax Cut and Jobs Act (TCJA) passed in 2017 resulted in a very large increase in the standard deduction associated with filing IRS Form 1040. For example, the 2020 standard deduction for a married couple filing jointly will be $24,800. This is nearly double the standard deduction amount for the same couple prior to the passage of TCJA.  This increase, coupled with a newly instituted cap of $10,000 on the State and Local Taxes deduction caused many people who had previously itemized deductions to be unable to do so under the new tax rules. This circumstance meant that many charitably inclined people were no longer able to receive a tax benefit for their eligible contributions.

Donor Advised Funds allow these individuals to itemize, at least in some tax years, by the concept of “bunching”. Bunching entails the grouping of multiple years of eligible tax deductions into one tax year. It can be done to some degree, by pre-paying property taxes, but grouping several years of charitable contributions into one tax year can be a powerful tax reduction tool. A second tax saving opportunity with DAF’s is associated with the method used to fund the DAF. Contributing highly appreciated securities to the DAF allows the donor/advisor to not only reap the charitable deduction from the amount donated, but also allows him/her to avoid the capital gains taxes that would have been incurred had the securities been sold for cash and subsequently donated. Thus, combining these two tax saving strategies can be an efficient way to reduce income taxes while also benefitting the recipient charities.    

If you would like to learn more about these and other wise financial planning moves, please contact us through our Level 5 Financial LLC website or via phone at 719-323-1240.  This material has been prepared for informational purposes only, and is not intended to provide, and should not be relied on for, tax, legal or accounting advice.  You should consult your own tax, legal and accounting advisors before engaging in any transaction.

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