America is the most charitable nation in the world as measured by the value of charitable donations. It’s in our DNA to be charitable. The IRS, through laws passed by congress provides great tax incentives for charitable contributions whether made by services rendered, cash donations or other “in-kind” asset transfers. Gifts to charity can be made during life (inter vivos) or at death (causa mortis) as a testamentary gift. Charitable gifts of any size are not subject to gift tax, although there are limitations on the type and amount of a charitable deduction a taxpayer can take on their income tax return. A solid understanding of the tax laws is needed regarding the type of property given, the type of charity (qualified or non-qualified) the timing of the contribution and for inter vivos giving the taxpayer’s adjusted gross income (AGI) in the tax year of the charitable gift.
Charitable trusts and private foundations offer great flexibility and control of your assets in estate planning while fulfilling the timing of your philanthropic goals. Estate tax laws allow unlimited charitable contributions. For some wealthy taxpayers, if structured properly, testamentary charitable gifts are more tax efficient for your beneficiaries than leaving all your assets to non-charities.
Donor advised funds (DAFs) fit somewhere between direct gifts and gifts made through a trust or private foundation. In the simplest form the way DAFs work is the donor deposits assets to a DAF and invests the proceeds with the expectation of asset growth. The donor recommends grants to charities and the timing of the gift to be distributed by the DAF. As long as you choose a charity that is recognized by the IRS as a U.S. charitable organization the sponsor of the DAF will usually direct your gift to chosen charity. The timing of charitable gift remains in your control.
Tax benefits of Donor Advised Funds:
You do not pay capital gains taxes on assets you transfer to a DAF; you take the market value of the assets transferred as a tax deduction
Because you control the timing of the gift from the DAF to the charity, any asset appreciation while invested at the DAF is not subject to capital gains taxes
The assets you transfer to a DAF are removed from your estate; this avoids potential estate taxes on these assets
You claim a charitable income tax deduction in the year you contribute assets to the DAF, rather than the year your gift goes to the charity. This is a fantastic tax planning strategy for taxpayers that have variable taxable income from year-to-year, or one-time events such as the sale of a business, or large stock options sales. With the AGI limitations on the amount of charitable donations you can deduct in any given tax year, DAFs provide you with the ability to optimize your charitable deductions while providing you with the ability to continue to support your favorite charities in lean taxable income years.