Donor Advised Funds can be set up easily to accomplish both tax savings and charitable giving goals.  Most people think they need to have a big sum of money before considering setting up their own family charitable fund.  But Donor Advised Funds are the most popular charitable vehicles for donors at many levels of wealth.  You can start your own donor advised fund with as little as $10,000.  I generally recommend a minimum of $50,000 to my clients if they plan to request grants from the Donor Advised Funds to their charities within a short period of time, however.  I would like to discuss how to use DAFs in various situations in this article.

These are a few questions I have heard from clients relating to taxes, charitable giving and educating the next generation:

1. How can I get the best tax benefits today but decide what charities to support later?
2. How can I minimize the taxes on the sale of my business?
3. How can I minimize the taxes on the sale of my highly appreciated stock?
4. How can I teach my children and grandchildren our family values?

A Donor Advised Fund can be a solution for donors who:

• Experience a high income year and want to set aside assets now to fund future giving. 
• Want to minimize taxes, especially when selling highly appreciated stock.
• Prefer flexibility to change their charitable beneficiaries over time.
• Want to engage family members in charitable giving as a way to pass on family values.
• Are concerned about the time and complexity in gifting appreciated assets to more than one charity.
• Are concerned about the cost & complexity of a private foundation.
• Plan to sell or just sold a business.

This is one example how a Donor Advised Fund is used.  A client of mine has a highly appreciated stock that is also a concentrated position in her portfolio, which she believes should be diversified over time, but wants to minimize the taxes she has to pay when selling the stock.  She has been giving cash to various charities including United Way at work through payroll deductions, totaling $7,000.  She plans to continue supporting her favorite charities and may include other charities later.  Her income is approaching the highest tax bracket (federal at 39.6% and Minnesota at 9.85%). 

I recommend that she sells $100,000 stock (10% of this stock) that realizes long term capital gains of $98,500.   We can use the proceeds from the sale to start building a diversified portfolio.  In the same tax year, I can help her set up a Donor Advised Fund at the American Endowment Foundation based in Ohio and this account can be opened at TD Ameritrade where I manage her other accounts.  The name of the Donor Advised Fund can be American Endowment Foundation FBO John and Jane Olson Family Charitable Fund.  She transfers a specific number of shares of the stock (fair market value of $100,000 on the day of gifting) to this fund.  The immediate charitable deduction for this tax year is $100,000.  As AEF is a public charity, she will have the maximum charitable deduction, up to 30% of adjusted gross income for current year.  As this charitable deduction fully offsets the capital gains from selling the stock, she does not have increased income taxes for the year.  I can manage the assets ($100,000) inside the Donor Advised Fund for her by selling the stock at a specified price and then investing the proceeds in diversified securities.  No tax reporting is needed for the sale inside the fund.  She can request grants online to charities throughout the U.S.  In addition, she can decide when and how to make charitable grants.  She can distribute final grants at death or appoint successor advisors (husband and children) in perpetuity. 

Before using this strategy, to convert this stock to cash of $7,000 before making contributions to charities, she needs to sell about $10,711 stock with realized gains of $10,550 and pay taxes of about $3,550 ( federal long term capital gains tax of 20%, 3.8% net investment tax and 9.85% Minnesota tax). 

This $3,550 tax savings in fact stays inside this Donor Advised Fund, continuing the growth, and the future growth is never taxed.  Instead of donating cash to charities every year, she is going to request grants from this DAF, which is more convenient and tax efficient.   If she requests $7,000 grants to her charities each year, and assumes the assets’ return is 5% per year, this one-time gift can fund her gifting goal for the next 25 years.

In the future, she can choose to transfer more shares of this appreciated stock to this DAF when she needs additional charitable deductions to reduce income taxes.  She can choose to give out more or less each year to charities.  She does not take charitable deductions again when she request the grants from this fund.

This example shows how simple it is to accomplish multiple goals by working with your trusted financial advisor: diversification to reduce concentrated stock risk, minimize income taxes, meeting charitable goals and teaching children family values in a simple, smart, and meaningful way. 

Establishing a DAF can be simple, quick and with no upfront cost.  AEF DAFs have a much lower expense than many other DAF programs or private foundations.  Clients receive a written letter from AEF acknowledging the gift that is used as a tax record, which is very convenient.  AEF does not provide investment advice, clients work with the financial advisor to select investments.  Clients can see the positions, activities and performance in their DAFs using our client portal, the same way as their other investments we manage.

If you just sold a business or have much higher income this year, now it is the time to talk to your advisor about how to reduce income taxes and start to have a strategic way of giving to your favorite charities in order make the most impact.