donor advised funds in depth

In short

A friend of mine once kept a shoebox of charity receipts, and every April he dug through it with a sigh. A donor advised fund is a way to put that shoebox in order. You give money or investments to a public charity that runs the fund, and you can claim the tax deduction in the year of the gift. Then you recommend, over months or years, which charities receive grants from the account. The gift itself cannot be taken back, because the money now belongs to the sponsoring charity. Deduction limits are set by law, so check the current figures on the IRS pages before you act. If you give appreciated stock, you can skip the capital gains tax on the growth. Keep the receipt the sponsor sends, since IRS Publication 526 explains why that paper matters.

The whole of it

What it is

I once watched a neighbor pour a bucket of water into a rain barrel. He could not drink it all that day, but it was saved for later. A donor advised fund works about the same way. You pour a gift into an account at a sponsoring charity, and you spend it on good causes when you are ready.

The sponsor is a public charity. Community foundations are one kind. Some financial firms run charities that offer these funds too. Once your gift lands, it belongs to that charity, which holds legal control. You keep what the law calls advisory privileges. In plain words, you suggest where grants go, and the sponsor reviews each request and sends the money.

Because the gift is complete, the tax deduction comes in the year you make it. The grants to the working charities can come later. That gap in time is the whole point of the thing.

How it works

If you are holding a pile of year end paperwork, here is the path. You open an account with a sponsor and make a gift. That gift can be cash, or it can be stock, or even other assets the sponsor agrees to accept. The sponsor sends a written acknowledgment. Hold on to it, because IRS Publication 526 sets out the proof a donor needs to back up a gift.

Next, the money gets invested inside the fund. Any growth stays in the account and is not taxed. When you are ready, you ask the sponsor to send a grant to a charity of your choosing. The sponsor checks that the charity is eligible, then pays it.

The deduction itself has limits. The IRS sets a cap tied to your adjusted gross income, which is the total income figure at the bottom of the first page of Form 1040, after certain adjustments. The cap differs for cash and for appreciated property. The rules also allow extra gifts to carry forward for a number of years. The exact percentages and the carryforward period are set by law and change, so look at them here: the current figure, which the official source publishes each year for cash gifts and the current figure, which the official source publishes each year for appreciated stock. The carryforward is the current figure, which the official source publishes each year years.

You also have to itemize to claim the deduction. Itemizing means listing your deductions on Schedule A rather than taking the standard deduction. That is the step that trips up many a kind giver, and we will come back to it.

The numbers, and where to find yours

I have never met a person who enjoyed hunting for a tax figure, so let me point you to the right door. The deduction limits live in IRS Publication 526, called Charitable Contributions. The IRS also explains how to document gifts in that same publication. Your adjusted gross income sits on your own Form 1040, so your personal cap starts from a number you already have.

The standard deduction, which decides whether itemizing even makes sense, is the current figure, which the official source publishes each year for a married couple filing together and the current figure, which the official source publishes each year for a single filer. If your itemized deductions do not beat that figure, a gift may not lower your tax bill at all.

Many sponsors set a minimum to open an account. Those minimums, along with the annual fees, vary by sponsor. Ask each one for its fee schedule in writing. Fees come out of the account, and they matter over many years.

A worked example

Let me tell you about a woman named Marlene. She is 58, files as single, and earns $140,000 a year. She owns stock she bought long ago for $10,000, and it is now worth $40,000. She wants to give $40,000 to charity over the next few years.

Her first thought was to sell the stock and donate the cash. The sale would create a gain of $40,000 minus $10,000, which is $30,000. If her long term capital gains rate were 15 percent, the tax would be $30,000 times 0.15, or $4,500. She would then have only $35,500 left to give. That rate is only an illustration, and the real rate depends on her income and the law that year.

So Marlene tried another path. She gave the shares straight to a donor advised fund. The fund sold them with no tax, since the sponsor is a charity. The full $40,000 went into her account. That is $4,500 more working for charity than the sale first would have allowed.

Now the deduction. The limit for appreciated stock held longer than a year is the current figure, which the official source publishes each year of her adjusted gross income. Say that limit were 30 percent, just to run the numbers. On her $140,000 income, 30 percent is $140,000 times 0.30, or $42,000. Her $40,000 gift fits under that cap. Her deduction is $40,000, if she itemizes and the stock was held more than a year.

She then recommended grants of $8,000 a year for five years. Five times $8,000 is $40,000. Her favorite food pantry got its first check the same spring. Marlene had made the gift and claimed the deduction in a single year. The giving itself took five.

Where it goes wrong

I made a mistake once, years back, that I still wince about. I assumed a thing was settled when it was not. Donor advised funds invite that same sort of slip, so let me name a few.

The first is thinking the money is still yours. It is not. The sponsor has the final say, and it can turn down a grant. Sponsors may also refuse certain requests, such as a grant that gives you a personal benefit. Tickets to a gala, for instance, can break the rules.

The second is skipping the itemizing question. If the standard deduction is bigger than all your itemized deductions, the gift may not cut your tax. Some people bunch several years of giving into one year to get over that line. That is a legal and common planning idea, though it needs care.

The third is missing paperwork. Publication 526 explains the records a donor must keep for a deduction to stand. Without the written acknowledgment, the deduction can be denied. Gifts of noncash property above set amounts bring extra forms, such as Form 8283. Large gifts of stock or other property may also need a qualified appraisal.

The fourth is fees and slow granting. The account earns growth, but fees come out of it. Some funds sit for years with no grants made. The Treasury Department and the IRS have put out guidance and proposed rules on donor advised funds, and I cannot say which parts are final. The IRS site shows the current status, so a giver can check it before making a large gift.

Last, the gift cannot fund a legal pledge you already owe. If you promised a charity a donation in writing, paying it from the fund may be treated as a personal benefit. A tax professional can sort out those cases.

Questions to answer before you leave this page

Have you checked whether your itemized deductions would beat the standard deduction? Do you hold stock that has grown, and have you owned it longer than a year? What are the sponsor's fees, and have you asked for them in writing? Is there a minimum to open the account, and can you meet it? How soon do you want grants to reach the charities you love? Have you saved the written acknowledgment for every gift? Do you know your adjusted gross income, so you can test the deduction cap? Would a tax professional help you read the current rules on IRS Publication 526 before you give?