The 2017 Tax Cuts and Jobs Act made sweeping changes that reduce income and transfer tax for many individuals, while nearly doubling the income-tax standard deduction. Other changes curtail or eliminate many popular itemized deductions.
The charitable deduction, however, does remain in effect as an itemized deduction and even provides a higher deduction threshold for cash donations to public charities. It presents an opportunity for high-income taxpayers who still have the ability and inclination to significantly donate to charity.
"Bunching" has become popular for aggregating the amount one would normally donate to charity over a number of years into a single year to maximize the deduction in the year of contribution. (This strategy requires careful planning for taxpayers who anticipate any carryover deduction in years that they may use the standard deduction.)
But what if a donor is not inclined to give an outsized donation at one time or has not yet decided which charities to benefit? Donating to a private foundation or a donor-advised fund may enable individuals to benefit from a current-year deduction, while having the time to carefully plan out charitable distributions. Since donations represent a form of investment (for charitable impact), it pays to consider your overall allocation of funds so you can properly vet and prioritize among charities.
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A donor-advised fund is a philanthropic vehicle established at a public charity. It allows a donor to make a charitable contribution, receive an immediate tax benefit and then recommend grants from the fund over time. DAFs have increased in popularity as a simpler form of private foundations, with no annual distribution, disclosure, investment excise tax requirements or upfront legal formation fees. DAF sponsors can also assume the administrative responsibilities related to foreign charitable recipients.
In addition, deduction limits for donating to private foundations remain lower than those applying to DAFs. Individuals contributing cash to a private foundation cannot deduct more than 30 percent of their adjusted gross income in the donation year.
By contrast, DAF sponsors classify as public charities and therefore have a higher deduction limitation for cash contributions (60 percent of AGI, under the new tax law, as opposed to 50 percent). Similarly, donations of long-term appreciated marketable securities have a deduction limit of 20 percent of AGI if made to a private foundation, but 30 percent of AGI if made to a DAF. In all cases, donors can carry forward excess contributions to the subsequent five years (under the same AGI-based limitations).
The higher deduction limits for DAFs may benefit those who wish to reallocate out highly appreciated securities and benefit charities. Given prevalent market volatility, donating appreciated securities held for over a year may constitute the most tax-efficient way to ease out of a concentrated position without having to pay tax on realizing a sale, and claim a charitable deduction, as well. In this manner the charitable vehicle receives the full fair market value of the contributed asset, as opposed to an after-tax cash amount if the donor sold the securities first.
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Additional opportunities apply to pre-liquidity donations of complex assets (e.g., privately held business or real estate interests), which often comprise much of a wealthy individual's balance sheet. If the owner anticipates but has not yet committed to a taxable sale of such an asset, he or she may consider donating the asset to a DAF before the sale to benefit from a charitable deduction based on the asset's fair market value at the time of donation. Donations of privately held assets to a private foundation, by contrast, result in a charitable contribution based only on the donor's adjusted cost basis.
Private foundations do have the benefit of complete donor control over the investments and grant distributions made. A DAF, by contrast, has certain prescribed investment options and maintains ultimate control over any grant recommendation, although will generally comply with the donor's wishes if no compliance issues arise.
In many cases, individuals may use a DAF to complement an existing private foundation, to receive any part of the foundation's 5 percent required annual distribution that the family has not yet decided on how to allocate. It can also bypass annual 990-PF disclosure for grants that the family does not want to expose publicly.
"The optimal combination of charitable vehicles depends on both tax and charitable objectives. In all cases, donors should consult with their tax and wealth advisors ..."
In addition, individuals may choose to "stack" their donations, by maximizing the AGI limit applicable to private foundations, and contributing an additional amount in the same year to a DAF to benefit from the higher deduction limit applicable to public charities.
In recent years, DAFs have received adverse publicity as a vehicle used to withhold charitable distributions, while providing a current tax benefit. However, DAF sponsors have consistently reported aggregate annual payout rates to charity of near or above 20 percent of assets.
The optimal combination of charitable vehicles depends on both tax and charitable objectives. In all cases, donors should consult with their tax and wealth advisors to maximize the benefits that the charitable deduction still provides under the new tax law.
— By Julia Chu, senior philanthropy advisor at JPMorgan Private Bank Philanthropy Centre
