The Giving Tree

You want to donate some money to charity? I’ll suggest the most tax-efficient and flexible way to do so.

As a preface, you should understand that contributions to qualified charitable organizations (known as “501(c)3” non-profit corporations) can be tax deductible. But, this is only true if you itemize your tax deductions on Schedule A of your federal taxes. Most taxpayers don’t and instead take the standard deduction and in that case, there’s no federal tax deduction for charitable contributions.

With that context, if you’re considering more than a few small cash donations, I recommend establishing a donor-advised fund (“DAF”) for your lifetime charitable giving.

What’s a DAF?

A donor makes a charitable contribution of cash or investment securities to a public charity and is eligible for an immediate tax deduction for the full amount.

The funds remain in an investment account that is controlled by the donor who both recommends grants to charitable organizations and directs how the funds are invested until they’re disbursed (hence the name, “donor-advised fund”).

In effect, the donor receives the full tax deduction now but can distribute the funds later.

Why is a DAF better than donating directly to a charity?

First, if your income is high this year, you expect it to be lower in the future, and you itemize your deductions, a tax deduction for charitable contributions would offer a larger tax savings now than in the future.

Second, if you were to make a one-time large charitable donation to fund a DAF, it could be enough for you to benefit from itemizing your deductions, and that would also save you taxes.

These savings can be worth a lot — if you’re a high income earner and your marginal tax bracket is 33%, this means that the IRS is subsidizing 1/3 of your contributed amount.

There’s really no downside compared to making cash donations and you have the flexibility to select organizations at your pace and direct the contributions when you’re ready to do so. Also, see my next point.

Can you donate securities other than cash?

Yes, and for some people, this is a substantial benefit. Let’s say your employer went public and you’re lucky enough to own some equity that has a very low tax basis or you own shares of stock from many years ago and your tax basis of these shares is also low.

Donate these shares instead of cash. You’ll benefit three ways — your DAF will be credited with their market value, you’ll get a tax deduction for their market value, and you’ll avoid paying any capital gains tax on the appreciated stock because you donated it. That’s a pretty good deal.

Who sponsors these DAFs?

Many big financial institutions, including Fidelity, Vanguard, and Schwab have set up public charities to enable these DAFs. They all operate similarly but may have different features such as the investment options and the minimum donation size.

How much should you donate?

I’d encourage you to have at least a 10-year time horizon and if possible, look out over your lifetime. Donate as much as you feel comfortable doing over the entire period, especially if your income is high this year. You’ll maximize your lifetime tax savings by doing so.

Where can you direct the funds?

Essentially, any tax-exempt organization that is a “501(c)3” non-profit corporation as deemed by the IRS should be eligible to receive your funds.  The process is that you “recommend” where you’d like to send the funds and indicate the amount. The foundation that manages your DAF will verify its eligibility and then quickly send out a check to them.

There are some restrictions but these are the same as if you were donating directly. You can’t donate to organizations where you’re receiving value in return (e.g., paying for the trip to Cancun that you “won” in the silent auction fundraiser or paying for a table of attendees at the annual gala) and you’ll need to attest to that each time you recommend a grant.

What happens to the remaining funds when you die?

Typically, you can designate a “successor trustee” which is just as it sounds. When you leave this world, your successor trustee will control the investment and disbursement of the remaining funds.

Can you get the money back if you need it in an emergency?

No. It’s no longer yours as you’ve donated it to a public charity. If you think you’ll need this money in the future, reconsider how much you plan to donate.

So, if you want to plant a giving tree, consider creating a donor-advised fund.