Update on Donor-Advised Funds

https://www.wsj.com/articles/pros-cons-of-donor-advised-funds-11636402901?

The Pros and Cons of Donor-Advised Funds

WSJ · by Tom Herman Updated Nov. 11, 2021 10:00 am ET

Donor-advised funds, a highly popular way to contribute to charity, are continuing to attract rapidly growing numbers of admirers.

A new report by Giving USA Foundation, researched and written by the Indiana University Lilly Family School of Philanthropy, says contributions to these charitable-giving vehicles and grants from them “continue to grow at impressive rates, meaning that [donor-advised funds] are likely to play an even more prominent role in philanthropy in the future than they do now.”

Contributions to donor-advised funds (or DAFs) jumped to $47.85 billion in 2020, up more than 20% from 2019, according to a new survey by National Philanthropic Trust. The value of grants from DAF accounts to other charities rose 27% to $34.67 billion, the largest grant-making increase in a decade. Charitable assets in these DAFs totaled $159.83 billion last year, up 9.9% from 2019.

Philanthropists, large and small, prize DAFs for their tax benefits, convenience and simplicity, among other things. DAFs “can be extremely helpful” for many taxpayers seeking to time their charitable contributions for the maximum tax benefit, says Amy C. Arnott, portfolio strategist at Morningstar Inc. and author of several reports on the subject. But she cautions that they aren’t ideal for everyone, and DAFs include important limitations that taxpayers should be aware of.

With that in mind, here is a look at what makes these charitable-giving vehicles so popular, their limitations, and why some lawmakers are trying to impose new rules.

Tax strategy

In a typical case (with a few important exceptions discussed below), you make a donation to a DAF and claim a tax deduction for the year in which you make it—assuming that you itemize your deductions for that year, instead of choosing the standard deduction. Then you have an important choice: You can advise the fund which working charities should receive your contributions or you can wait until future years to select your favorite recipients. You don’t have to make a decision now in order to get the deduction.

“Because most investors now take the standard deduction instead of itemizing, it can be beneficial to ‘bunch’ charitable donations by making a larger donation in a single year, which might push you past the threshold for itemized deductions, instead of making smaller annual donations that might not be tax-deductible,” Ms. Arnott wrote in a report in May. “Donor-advised funds can facilitate this strategy because donors can make a bigger contribution to a donor-advised fund in a single year and take the itemized deduction up front, but still make charitable contributions over time.”

For example, suppose you know you will itemize your deductions for this year but probably will take the standard deduction for 2022. You haven’t decided where you want your gifts to go, or how much to give to each charity. Consider bunching your donations into a DAF this year, when they would be deductible, and advise the fund in future years which qualified charities should receive your generosity, and how much, whenever you decide.

Meanwhile, your money grows tax-free, which can enable a small contribution today to grow into a more meaningful gift whenever you choose in the future.

Whatever the case, keep in mind that a contribution to a DAF is irrevocable, meaning that “donors can’t get their money back if they change their mind,” says Una Osili, associate dean for research and international programs at the Lilly Family School of Philanthropy.

Choosing funds

Donors have a large number of choices, ranging from such familiar names as Fidelity Charitable, Schwab Charitable and Vanguard Charitable to community foundations, religious and educational organizations and other institutions. (Personal disclosure: My wife and I have used Fidelity Charitable for many years.)

But before making your choice, do some basic homework about the fund, its policies and background. Check the fine print for details on fees and other important details that can vary widely from fund to fund. Among the many other things to consider:

• Does the fund have a minimum initial investment requirement? If so, how much?

• If there is a minimum initial investment requirement, what is the fund’s policy if your fund dips below the minimum?

• Does the fund have a minimum-size grant? If so, how much?

• What are the investment options?

• What types of assets will the fund allow you to contribute?

• Do you have any assets you want to donate that are highly complex and hard to evaluate?

• How much help and advice, if any, would you like to have in researching which charities deserve your support?

Limitations

Donations to DAFs don’t count toward certain tax breaks.

Among them is a special charitable-giving deduction—available for this year and last year—to taxpayers who take the standard deduction. Taxpayers who don’t itemize can claim a charitable deduction for 2021 for cash donations of as much as $300 if they’re single, or as much as $600 if married and filing jointly. This applies to cash contributions to most charitable organizations—but contributions to supporting organizations or to set up or maintain a donor-advised fund “do not qualify,” the IRS says on its website.

The IRS also points out that contributions to DAFs don’t qualify for another separate, temporary provision that applies to returns for 2021 and 2020. That change generally allows people to deduct qualified cash donations of as much as 100% of their adjusted gross income. (Read more on charitable giving in my recent column.)

Donors also cannot use DAFs to make ”qualified charitable distributions” from their IRAs. A qualified charitable distribution typically enables taxpayers who are 70½ or older to transfer as much as $100,000 a year directly from an IRA to a qualified charity. They don’t have to include any of that transfer in their income, and they can count it toward their required minimum distribution from the IRA for that year.

Proposed changes

Some lawmakers, professors and others want changes that include requiring distributions from DAFs (with certain exceptions) to qualified charities within certain time limits, instead of the current system that gives people unlimited amounts of time. Sen. Chuck Grassley (R., Iowa) and Sen. Angus King (I., Maine) have introduced the Accelerating Charitable Efforts (or ACE) Act, which they say would help speed up the flow of money to working charities.

The fate of the bill remains unclear. But it’s worth watching, whether or not it passes this year, because it might return again in this form, or some other form.

Mr. Herman is a writer in California. He was formerly The Wall Street Journal’s Tax Report columnist. Send comments and tax questions to taxquestions@wsj.com.

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