Welcome to our latest blog post, “Can a Private Foundation Donate to an Advised Fund?” In this post, we focus on addressing a question in the minds of many philanthropically minded individuals, couples, and their families: How to utilize their assets to fund a greater good that impacts more people.
With the increasing popularity of private foundations and Donor-Advised Funds in charitable giving, it’s no surprise that questions about the intersection of these two tools have started to surface. We understand the world of philanthropy can be complex, so we’re here to break down these financial strategies into bite-sized, digestible pieces to help you make informed decisions about your family’s charitable strategy.
In this blog, we’ll address the following topics:
- What is a Private Foundation, and How do They Work?
- What is a Donor Advised Fund (DAF), and How do They Work?
- Examples of When Private Foundations Can Donate to DAFs
So, let’s dive in and explore if and how a private foundation can donate to a DAF.
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What is a Private Foundation?
A private foundation is a non-profit organization that a single individual, family, or business typically funds. Its main purpose is to support charitable causes through grants and various gift-giving programs. Unlike a public charity that relies on continuous donations from the general public, a private foundation is primarily funded by its initial endowment, which is invested in ways that generate income for its charitable activities.
How to Set Up a Private Foundation
Establishing a private foundation involves several steps. Firstly, the founders must define the foundation’s mission, which could revolve around supporting education, alleviating poverty, funding medical research, or any other noble cause. Then, a legal entity must be created, usually as a corporation or a trust. The foundation must be registered with the IRS and the appropriate state regulatory bodies. As part of the registration process, it must demonstrate that its purpose is indeed charitable and it will operate in a way that benefits its beneficiaries.
How Does a Private Foundation Work?
Once established, a private foundation uses the income generated from its assets to fund various charitable activities. The foundation’s board of directors, often comprised of the founder(s) and other family members they select, decide on allocating funds.
Three ongoing activities include reviewing grant applications from nonprofits, determining the worthiness of these applications based on the foundation’s mission, and making the all-important distribution decision.
Private foundations are required by law to distribute a certain percentage of their assets annually for charitable purposes, ensuring they continually fulfill their philanthropic purpose.
What is a Donor-Advised Fund (DAF)?
A Donor-Advised Fund (DAF) is another powerful device that is used for philanthropy. It’s an account that a public charity sponsors, but the donor who donated retains advisory privileges over the investment portfolio and the distributions from the pool of assets. The purpose of a DAF is to facilitate the donor’s charitable giving, allowing them to make a charitable contribution, receive an immediate tax benefit, and recommend grants from the fund to their favorite charities each year.
How to Set Up a DAF
Setting up a DAF is relatively straightforward. It begins with the donor making an irrevocable contribution to a public charity that sponsors a DAF program. This could be a community foundation or a charitable fund offered by a financial institution. The donated assets can include cash, stocks, real estate, and sometimes even more unique types of assets. Once the donation is made, the donor receives an immediate tax deduction.
How Does a DAF Work?
The operation of a DAF is quite flexible, which is part of its appeal to high-net-worth individuals and families. Once the donation is made, the funds are invested and can grow tax-free. The donor can then recommend grants to IRS-qualified public charities at their leisure. This means they can take their time to decide which causes they want to support without any legal obligation to make annual distributions.
Think of a DAF like this: it’s like having a personal charitable savings account that grows over time and allows donors to support the causes they care about most.
Can Private Foundations Donate to DAFs
At first glance, it might seem odd for a Private Foundation to donate to a DAF. After all, don’t both serve philanthropic purposes? However, there are circumstances in which a foundation might consider contributing to a DAF.
- Direct Transfers: This is the most straightforward way for a private foundation to donate to a DAF. The private foundation can write a check or transfer securities directly from its account to the DAF.
Depending on the foundation’s gift-giving strategy, this can be a one-time donation or a series of recurring donations. This method is simple and convenient, but it’s important to note that the foundation must meet its 5% annual minimum distribution requirement separately.
- Winding Down: If the private foundation considers ceasing operations, it can transfer its remaining assets to a DAF. This allows the foundation to ensure its charitable objectives remain intact even after ceasing to exist. The DAF would distribute funds to specified charities over time based on the donor’s recommendations.
- Transferring Income: The private foundation can transfer some or all of its income (from investments or other sources) to the DAF. This can be an effective strategy if the foundation wants to support a specific cause but prefers to outsource the grantmaking process to the DAF.
- Partnership Approach: A private foundation can set up a DAF to work with its existing give-gifting strategies. For example, a foundation could use the DAF for more immediate, responsive giving (since DAFs can distribute funds quickly) while keeping the foundation for larger, more mainstream gift-giving initiatives.
- Succession Planning: For individuals who have set up private foundations, a DAF can be an excellent tool for engaging the next generation. They can allow younger family members to have a DAF under the foundation’s umbrella to learn about philanthropy and make gift-giving decisions.
Remember, each approach has pros and cons; the best choice depends on your unique circumstances and goals. It’s also crucial to consult with a tax planning advisor or attorney specializing in nonprofit law, as complex regulations will govern these gift-giving strategies.
Tax Implications When Donating to Private Foundations and Donor-Advised Funds (DAFs)
- Initial Tax Deductions:
You get an immediate tax deduction when contributing to a Private Foundation or a DAF. That means you can reduce your taxable income in the year you donate. Hence you have more control over the payment of taxes. However, deduction limitations impact the amount of taxes you pay:- You can deduct up to 60% of your adjusted gross income (AGI) for cash donations to a DAF.
- The limit for donations to Private Foundations is lower, up to 30% of your AGI for cash donations.
- Appreciated Assets:
If you’re holding onto assets with substantial appreciation, such as stocks or real estate, donating them can provide substantial tax benefits. Donating these directly to a DAF or Private Foundation avoids the capital gains tax that would typically apply if you sold these assets.- For DAFs, you can deduct the fair market value of the donated assets up to 30% of your AGI.
- For Private Foundations, you can deduct the fair market value up to 20% of your AGI.
- Estate Tax:
By contributing to a DAF or Private Foundation, you can reduce the size of your taxable estate, lowering the estate tax your heirs may have to pay when you pass on. The assets you contribute are removed from your estate, reducing its overall value. - Taxes on Investment Income:
Once assets are in a DAF or a Private Foundation, they can be invested and accumulated tax-free. Significant assets can accumulate over time to fund current and future charitable distributions. However, Private Foundations pay an excise tax on their net investment income. The rate is generally 1% or 2%, depending on the foundation’s charitable distributions. DAFs, on the other hand, are not subject to this tax. - Required Distributions:
Private Foundations must distribute at least 5% of their assets annually for charitable purposes. If they don’t meet this requirement, they may face penalty taxes. DAFs have no such mandatory distribution requirement, offering more flexibility for donations (when, how much).
Remember, everyone’s financial situation is unique, and tax laws can change. Always consult a tax planning advisor or financial planner when making significant decisions about charitable giving or other financial matters.
Scott Marsh Financial, a Utah-based CERTIFIED FINANCIAL PLANNER™, is your go-to resource for detailed, personalized financial guidance. Our firm specializes in helping successful high-net-worth individuals and high-income earners develop and implement wealth management and philanthropic strategies.
Want to learn more? Get in touch! We’re more than happy to chat about how we can assist you in your journey, from retirement planning to exploring options for giving back through charitable donations. Let’s make your wealth work best for you, your family, future generations, and the causes you care about the most.
