Donor-advised funds: How to have your cake and eat it, too, on charitable giving

I wrote last week that changes in tax-exemption incentives may lower charitable giving in the United States by 5 percent, according to the nonpartisan Tax Policy Center.

Hopefully your giving won’t drop this year. If you still want to give, I thought I’d remind you of a cool solution for the merely comfortable but not necessarily extremely wealthy donor.

Donor-advised funds have suddenly become more valuable as a result of changes in tax law.

Of course, one key piece of finance advice I always give is to never do something just for the taxes, especially philanthropy.

In the charitable giving space, this means making a decision to give not because of the tax break but rather because you feel deeply that the organization receiving your funds is the right institution to address a problem of importance to you. The tax break should be a minor consideration rather than a primary reason to give.

Even though that’s true, I still want to have my cake and eat it, too. I want to donate, and I still want my tax break, gosh darnit!

Let’s say you’re in the habit of giving $1,000 per year to a charitable organization. You also have enjoyed that you often receive a tax benefit for your donation. If you’re in the 25 percent tax bracket, you could get $250 back on your taxes, and if you had been in the 39.6 percent tax bracket, you could have gotten $396 back on your $1,000 gift in the past.

Following the Tax Cuts and Jobs Act of 2017, a much smaller number of donors will benefit on their taxes from their charitable contributions because of the increase in a standard deduction to $12,000 for individuals and $24,000 for married couples.

Overall, a rise in the standard deduction per taxpayer seems fine and efficient to me, although charitable donors who miss out on their tax deduction might not like it.

But never fear, I’m here to remind you of a solution. The donor-advised fund has become additionally useful for this reason — namely a way to bunch your annual charitable contributions so you can get a tax break above the standard deduction.

An example may help. If you have a comfortable net worth and you know you’ll be giving away $1,000 every year for the next 25 years to your favorite charity, the change in the standard deduction now incentivizes couples to contribute $25,000 in 2018. Then in the years to come, you would continue to dole out your $1,000 largesse annually from your donor-advised fund.

The tax break would come in that single year of the big bunched-up contribution. If all your itemized deductions — like up to $10,000 in property taxes and thousands in annual mortgage interest — add up to more than $12,000 for individuals or $24,000 per tax-filing couple, you’ll get your charitable tax deduction.

Donor-advised funds act like mini-charitable foundations, allowing upfront tax advantages to a generous person who wants to give away her money over time. Normally, however, setting up a charitable foundation doesn’t make a lot of sense unless you’re looking to give away chunks of $5 million to $25 million at a time.

That doesn’t include me or the vast majority of households. But Americans of even moderate wealth are very generous, and the funds are like foundations for the generous and merely comfortable.

I wrote about these earlier because I find them kind of awesome, but it was the change in the tax law that reminded me of their extra awesomeness, given the higher standard deductions.

Joyce Beebe, fellow in public finance at the Baker Institute for Public Policy at Rice University, mentioned these advantages in her paper last month. “Charitable Contributions and the Tax Cuts and Jobs Act of 2017” detailed the effects of changes in tax law.

Beebe also cautioned that the IRS has asked for commentary from the public about donor-advised funds, given two ways they might be abused.

She explained to me the IRS’ concern.

First, donors who receive a personal benefit from their gift — such as an invitation to a superfancy gala event — are not supposed to also get tax deductions to the extent of their personal benefit. The $1,000 gala might only qualify as a $500 charitable gift if the combination of Champagne and Jay-Z performance add up to $500 in personal benefit. Using a donor fund, the IRS worries, could make it easier to mix up personal benefit and charitable benefit.

Second, the funds provide a level on anonymity to donors that the IRS thinks could be abused. Organizations sometimes restrict how much any one individual may give so that organization can continue to qualify for public funding. The IRS’ concern is that an anonymous donor fund could be used to circumvent those restrictions. Anyway, I’m sure nobody reading this is engaged in charitable tricks. I just wanted to pass on the latest.

Many brokerage and investment advisers offer donor-advised funds. The discount broker I use requires a $25,000 minimum to open a DAF, but other major ones will open your account for as little as $5,000. I would love to hear from any readers who have opened a DAF and can give testimony one way or another about their usefulness as a mini-foundation for the merely comfortable.

My personal confession is that I haven’t opened my own fund yet despite looking into it back in 2016. Kitchen renovations and children are expensive — that’s my current excuse. But the higher annual standard deduction may help get me over the hump.