What to consider when structuring a charitable gifting strategy: Comparing donor-advised funds, private foundations and charitable trusts

When it comes to gifting, there are numerous tax-efficient ways to donate to your favorite charitable organization. But if you are trying to develop a long-term, structured gifting strategy for the future, while also maximizing your tax benefits, what are the main options available, and which option is the most beneficial for you?

Three of the more “robust” gifting strategies that are commonly implemented are donor-advised funds, private foundations and charitable trusts. We are going to take a deeper dive into these strategies and discuss what factors you should consider when determining which option could work for you.

Strategy overview

Before we jump into the different considerations, let’s start with an overview of the strategies we’ll be discussing:

A donor-advised fund (DAF) is a charitable investment account that any individual can set up through a qualified institution. You receive a charitable deduction in the year that you irrevocably contribute to the DAF, and the funds within the account can be invested and grow tax-free. You can either contribute cash, or you can contribute appreciated securities such as shares of stock or mutual funds (without having to pay tax on the security’s gains). In the future, you can recommend grants from your DAF to qualified charitable organizations, and there’s no minimum grant that you must make each year.

Private foundations1 are charitable corporations or trusts that are set up as separate legal entities. Contributions to a foundation are generally tax deductible, the funds can be invested and they can grow tax-free. Foundations are governed by a board of directors and issue grants annually to a desired charity or list of charities, and there’s a minimum grant that must be made each year.

Charitable trusts are estate-planning vehicles that allow individuals to contribute assets to an irrevocable trust. You can receive a tax deduction for this contribution (subject to certain IRS calculations). There are two main types of charitable trusts: charitable remainder trust2 (CRT) and charitable lead trust3(CLT). To set up a CRT (as an example), you must establish an irrevocable trust and choose a charity that will be the end beneficiary of the funds. You will then select a trustee who will be responsible for investing the funds.

Moving forward, you, as the donor, will receive an annual income stream either for a set term, or for life. When the term expires, or you pass away, the trust is terminated and the designated charity receives all of the remaining trust assets (hence the name, charitable remainder trust).

The key difference between a CRT and a CLT is who receives the annual income stream, and who is the end beneficiary. In a CLT (contrary to what’s described above) the charity would receive the annual income stream and a non-charitable beneficiary would receive the remaining funds after a certain time period.

Factors to consider

1. Cost to implement and administer

DAFs offer an advantage here, as they typically have little-to-no setup costs. Establishing a DAF can be as simple as contacting a qualified institution and completing the necessary paperwork to open your account (no need for legal documents to be drafted).

Since private foundations are separate legal entities, there are costs associated with the formation, ongoing monitoring and administration of the foundation. Additionally, you need to consider the ongoing legal and tax compliance costs of operating a foundation. Foundations are subject to specific compliance regulations, as well as the need to maintain accurate records of all income, expenses, sales, investment activity and distributions on an annual basis. Plus, they are governed by a board of directors.

Charitable trusts have formation costs associated with drafting the trust’s legal documents, and these costs will vary depending on the attorney. There are also ongoing tax/compliance administrative costs, and the trustee needs to ensure that the annual income distribution requirements are met (these distribution requirements vary dependent on how the trust is designed).

A key ongoing cost to consider for all of these strategies relates specifically to the investments. There are three typical costs associated with investing: 1) an investment management fee that’s typically paid to the financial institution/financial advisor, 2) an expense ratio for the underlying holdings within the account and 3) transaction costs. These costs can be controlled, to a certain extent, dependent on where the accounts are held.

2. Control of assets, charitable beneficiaries and distributions

DAF assets are legally no longer under your control and are deemed to be outside of your estate. As the donor, you can advise on how the assets are used (i.e., where they are distributed) but there is no legal obligation for the funds to be used as you wish (although most DAF assets are distributed according to the donor’s wishes). There can be certain restrictions set forth by the financial institution on how the assets are invested, and typically private foundations offer more flexibility in their investment options.

Individuals can change how much they’d like to distribute to a qualified charitable organization, as well as which organization they’d like to gift to (as long as it’s a qualified charitable organization), and there is not a minimum amount that must be distributed each year. The key takeaway here is DAFs are generally limited to only making grants to qualified 501(c)3 charitable organizations, and they cannot distribute funds to individuals.

Similar to DAFs, private foundations generally must make grants to public charities, unless the grants made to non-public charities are for a charitable purpose (we recommend speaking with a qualified estate planning attorney if you find yourself in this situation).

Unlike DAFs, private foundations must make a minimum grant each year worth 5% of the investment assets’ fair market value. Additionally, private foundations are able to gift funds directly to an individual for a scholarship, but the foundation must have the transaction approved by the IRS. When it comes to scholarships, a key consideration for individuals is how much control do you want to have over the scholarship funds (e.g., if more control, then a foundation may be more appropriate).

Private foundations and DAFs have restrictions against certain transactions that could benefit (either directly or indirectly) the donor, persons related to the donor, the founder of a private foundation and/or related persons. We recommend considering any possible future transactions you may want to make with related persons to determine if those transactions would be allowed under either a foundation or a DAF.

For charitable trusts, the trustee directs how the trust assets will be invested, and grantors can have some control over the investments dependent on who they name as trustee. An option would be for the donor or a family member to serve as trustee and direct the investments. However, this approach could have a potential negative long-term impact if the trustee doesn’t have the appropriate knowledge and expertise to prudently invest the assets.

One downside of charitable trusts is that the desired charity (or charities) must be selected when the trust document is drafted, so you may be deciding years in advance of when the charity would receive any funds. Additionally, charitable trusts must make required distributions each year, and the distribution amount can either be a set annual amount or a percentage of the trust’s assets (dependent on how the trust is created).

3. Tax implications

First and foremost, we recommend you consult with your tax advisor to determine the appropriate tax effects of any charitable gifts.

As you can imagine, each of these strategies present tax benefits to donors, but to varying extents. With each of these strategies, individuals can receive a tax deduction in the year that a gift is made to the charitable account (DAF, foundation or charitable trust). Individuals do not receive an additional deduction in the year that the charitable account distributes funds to a qualified charity. As an example, if you donate $50k to a DAF in 2020, you’ll receive that charitable deduction on your 2020 tax return. If you then distribute that $50k from the DAF to a desired charity in 2021, you do not receive another tax deduction for this distribution in 2021.

Individuals can increase the tax advantages of these strategies by contributing appreciated securities instead of cash. By donating appreciated securities, you would avoid paying capital gains tax on the assets contributed and receive a tax deduction for the full market value of the securities (subject to certain AGI limitations). We recommend discussing potential tax deduction amounts with your tax advisor.

The IRS imposes certain limits4 based on an individual’s adjusted gross income (AGI) when determining how much of a gift you can receive a deduction for. This deduction also depends on what type of organization you are gifting to. One important item to note is that as part of the CARES Act, the AGI limitations have been modified for 2020, but these modifications do not impact donations made to DAFs or private foundations.

Given the changes to the state and local tax (SALT) deduction, as well as the standard deduction resulting from the Tax Cuts and Jobs Act of 2017, if you would not typically be itemizing your deductions, you could use one of these strategies to “pre-fund” multiple years of charitable contributions at once. These strategies are also beneficial in high-income years, such as when an individual sells a business or receives a large bonus.

4. Privacy

DAFs allow individuals to remain as private as they would like to be. When making a grant from a DAF, the grantor can choose to tell the charity who the gift is from, or they can choose to make an anonymous gift.

Private foundations on the other hand, have an annual compliance filing with the IRS, Form 990-PF. This is a public form that lists all contributors, directors and key employees, as well as a summary of the foundation’s charitable activities.

Charitable trusts also have an annual compliance filing with the IRS, Form 5227. Most of the Form 5227 is available for public inspection, except for Schedule A. This part of the form lists any current distribution schedules, donor information, additional asset information and donation information from individuals and non-charitable entities (as detailed in this IRS publication5).

Ready to choose from these charitable giving strategies?

There are many considerations when thinking about the most appropriate charitable gifting strategy. If you would like to take a deeper dive in determining what strategy could be most appropriate for you, contact a member of our team.

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Wipfli Financial Advisors, LLC (“Wipfli Financial”) is an investment advisor registered with the U.S. Securities and Exchange Commission (SEC); however, such registration does not imply a certain level of skill or training and no inference to the contrary should be made. Wipfli Financial is a proud affiliate of Wipfli LLP, a national accounting and consulting firm. Information pertaining to Wipfli Financial’s management, operations, services, fees and conflicts of interest is set forth in Wipfli Financial’s current Form ADV Part 2A brochure and Form CRS, copies of which are available from Wipfli Financial upon request at no cost or at www.adviserinfo.sec.gov. Wipfli Financial does not provide tax, accounting or legal services. The views expressed by the author are the author’s alone and do not necessarily represent the views of Wipfli Financial or its affiliates. The information contained in any third-party resource cited herein is not owned or controlled by Wipfli Financial, and Wipfli Financial does not guarantee the accuracy or reliability of any information that may be found in such resources. Links to any third-party resource are provided as a courtesy for reference only and are not intended to be, and do not act as, an endorsement by Wipfli Financial of the third party or any of its content or use of its content. The standard information provided in this blog is for general purposes only and should not be construed as, or used as a substitute for, financial, investment or other professional advice. If you have questions regarding your financial situation, you should consult your financial planner, investment advisor, attorney or other professional.
Kyle Griffith
Kyle Griffith

CFP® | Financial Advisor

Kyle Griffith is a Financial Advisor with Wipfli Financial Advisors, LLC, based in the Chicagoland area.

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What to consider when structuring a charitable gifting strategy: Comparing donor-advised funds, private foundations and charitable trusts

time to read: 7 min