By Bryan Lee, CFP®, MBA
Do you want to minimize your taxes and be generous at the same time? I thought so. Donor-advised funds could be a great option to lower your taxable income, thereby decreasing the amount you pay in taxes—and simultaneously give more money to causes you care about. It’s a win-win situation.
Charitable Giving Under The Tax Cuts and Jobs Act (TCJA)
If you’re charitably inclined, you’re probably used to itemizing your deductions. However, with the increased standard deduction and the limit on deductions for state and local taxes, you may not have received as much of a tax benefit for your giving in the past few years as you have previously since the TCJA went into effect in 2017. Essentially, the TCJA reduced the federal income tax subsidy for charitable giving by one-third, raising the after-tax cost of donating by about 7 percent. (1)
What Is a Donor-Advised Fund?
This is why donor-advised funds (DAF) are gaining popularity. A DAF acts as a philanthropic investment account. You put money into it for the purpose of giving to charity (either now or in the future) and any amount not used for immediate donations is invested so it can grow until you are ready to donate. Unlike a normal investment account, though, all contributions are irrevocable. Once you put an asset into a DAF, you can’t take it back.
Because you can’t take back your contributions, they are considered completed charitable gifts and are immediately tax-deductible. You can take the tax deduction the same year as the contribution, even if you wait several years to pass the money on to a final charity. Though you don’t technically retain ownership when you put money or assets into a DAF, you are still able to guide, request, and recommend where the money goes. You get to name your DAF account, advisors, successors, and beneficiaries, and the custodian of the DAF makes the ultimate decision on where the funds go. If you’re worried about letting control of your money go, know that most DAF custodians will honor donor wishes as long as the recommendation complies with legal and tax requirements and grant-making policies.
Tax Benefits of a Donor-Advised Fund
DAFs offer several tax benefits. First, you get to take an immediate deduction when you contribute, even if the money has yet to be given to the charity of your choice. Any limit to the deduction you’re allowed to take depends on what kind of assets you contribute to the DAF.
Publicly traded securities are a popular asset to contribute to a DAF. This is because you can avoid paying long-term capital gains taxes and still deduct the fair market value of the securities (if held over a year). If you buy a security at $100 and put it in a DAF when it’s worth $200, you get to deduct $200 of charitable giving without paying taxes on the $100 in gains.
Contributions of long-term capital gain property, like appreciated securities, can be deducted up to 30% of adjusted gross income (AGI). For all other cash contributions, you can deduct up to 60% of your AGI. If your contributions exceed your deductible limit, you can carry them forward to the next tax year. (2)
Also, all contributions can be invested within the DAF to grow tax-free. Once assets are in a DAF, they belong to a charity and are therefore exempt from taxes. (3)
How Are Donor-Advised Funds Used?
Let’s assume all your spending numbers will be the same for the years 2022 and 2023. The 2022 standard deduction for a married couple filing jointly is $25,900, (4) and for now, we’ll assume it stays the same for 2023. If your itemized deductions total $26,000 each year (comprising, for example, of $10,000 of state and local taxes, and $16,000 of charitable donations), that means you only receive a tax benefit for $100 of your giving in both 2022 and 2023 ($26,000 itemized minus the standard deduction of $25,900) and your total deductions over the two years are $52,000.
Now, instead, imagine that you open a donor-advised fund in 2022 and contribute $32,000 to it to cover your charitable giving for 2022 and 2023. In 2022, you will have itemized deductions of $42,000 ($10,000 of state and local taxes, and $32,000 of donor-advised fund contributions). Then in 2023, you can simply take the standard deduction since you have no charitable giving to report. Your total deductions over the two years will be $67,900.
By utilizing a donor-advised fund, you end up with $15,900 more in deductions over the course of two years. If you are in the 35% tax bracket, that’s a tax savings of over $5,500. If you donate appreciated securities to the DAF, your tax savings will be even greater because you will not face capital gains tax on the disposal of the donated assets. If you time the donor-advised fund contribution to align with a year of particularly high income, the tax savings can be further magnified.
Are You Ready to Save Money With a Donor-Advised Fund?
You enjoy giving to causes you care about, so don’t let tax laws cause you to limit what you would otherwise like to give! Even with the new higher standard deductions, donor-advised funds make it possible to continue receiving a tax benefit for charitable giving.
We at Strategic Financial Planning would love to partner with you to help impact our world for the better. Our unique client-first financial life planning approach and process helps clients like you get the most out of life. Your giving is a critical piece of that puzzle. Discover, design, and live the life you want by aligning your finances with your vision and values. If you want to see if a DAF is the right fit for your goals, call (972) 403-1234 or contact us online to set up a complimentary get-acquainted meeting so we can see if we are a good fit!
Bryan Lee is the founder and president of Strategic Financial Planning, Inc., an independent, fee-only financial advisory firm. With more than 27 years of industry experience, Bryan uses a unique client-first financial life planning approach and process to help his clients get the most out of life. Bryan earned his Bachelor of Business Administration in finance and his MBA in international finance from the University of North Texas. He is also a CERTIFIED FINANCIAL PLANNER™ professional.Bryan is actively involved in his community and industry and has served on the boards of several associations and charities, including the Dallas/Fort Worth chapter of the Financial Planning Association, the National Association of Personal Financial Advisors, Family Services of Plano, the CITY House, and the Journal of Financial Planning. Bryan has been featured in local and national media, including The Wall Street Journal, Investors Business Daily, CNNfn, USA Today, SmartMoney, Kiplinger’s Personal Finance, Financial Planning Magazine, The Dallas Morning News, and Dow Jones Newswires. And, he has been recognized as a Five Star Wealth Manager and one of Dallas’s Best Financial Planners in D Magazine every year since its inception and recently as a Top Wealth Manager. To learn more about Bryan, connect with him on LinkedIn.