When making donations to charity, tax incentives can be very important. Not all donations are treated equally in the eyes of the IRS. Determining factors revolve around the type of foundation that you are gifting to, along with what you are giving. Tax-smart giving should be considered whenever making a charitable gift.
What Type of Organization Are You Giving To?
Charitable organizations are not all created equally for the purpose of income tax deduction treatment for gifts made by donors. For example, a gift to your church, a school, the local food bank or your DAF are considered donations to a public charity. Public charities offer the best tax incentives by allowing gifts of cash (up to 60% of your AGI), gifts of tangible property, real estate and closely-held business ownership held at least 12 months can be deducted at fair market value (up to 30% of your AGI).
Gifts to private foundations and other organizations that are not considered public charities are treated differently. Gifts of cash (up to 30% of your AGI) and publicly traded stock (up to 20% of your AGI) are deductible at fair market value. However, gifts of tangible property, real estate and closely-held businesses are only deductible at a cost basis level.
Donor Advised Funds
A DAF is a charitable giving account administered by a public charity and receives public charity tax treatment. Donors may donate assets to the account and receive an immediate income tax deduction at fair market value. Over time, donors recommend charitable grants to their favorite 501(c)(3) public charities while the DAFs funds remain invested, potentially growing tax-free.
Private Foundations
A private foundation is an independent charitable entity, typically set up by an individual, family or corporation. It is its own legal entity, files its own tax return and is responsible for making grants, managing investments and adhering to strict regulations outlined by the IRS. Private foundations require ongoing administration, including annual filings, board meetings and compliance with minimum payout requirements as well as federal excise tax on net investment earnings.
Key Differences in Tax Deductions
Deduction Limits for Cash Contributions
A big difference between public charities and private foundations is the tax deductibility of the donor’s gift.
- Public Charities (including DAFs): Donors giving cash can claim up to 60% of their adjusted gross income (AGI).
- Private foundations: Donors giving cash can claim up to 30% of their AGI.
Any donations that exceed the 60%/30% threshold may carry forward any excess charitable deductions for an additional five years.
Deduction Limits for Non-Cash Contributions
Many donors contribute appreciated securities, real estate, business ownership or other non-cash assets to maximize tax efficiency.
- Public Charities (including DAFs): Donors can deduct up to 30% of AGI for non-cash contributions, such as stocks or real estate, based on the fair market value of the asset.
- Private Foundations: Donors can deduct up to 20% of AGI for non-cash contributions, but deductions are limited to the cost basis of the asset rather than its fair market value.
This means that public charities (including DAFs) offer greater tax advantages for donors contributing highly appreciated assets, as they allow for deductions based on full market value rather than the original purchase price. Any donations that exceed the 60%/30% threshold may carry forward any excess charitable deductions for an additional five years.
Immediate vs. Gradual Giving and Deduction Timing
One of the best things about using a DAF in a charitable giving plan is that donors can make donations when time is right for them. Many gifts are made before the sale or liquidation of appreciated property. With proper planning, the timing of the gift can greatly increase the amount that makes it downstream to charitable organizations. Once donated, the donors can then make grants to public charity over time.
A DAF, or other public charity is often the best tax-smart option for donors that want to lower their taxable income in a high-income year. Charitable donations to a DAF or other foundation let them receive a full tax benefit right away and gives them the freedom to choose when to give the money to charities.
Payout Requirements
All foundation types, including DAFs, are designed to give grants to charities over time and with annual guidelines or regulations.
- DAFs: Are not required by law to make payments every year, but a DAF should average 5% annually over time. The DAF sponsor will outline giving guidelines per IRS recommendations and their own organizations giving philosophy.
- Private foundations are required legally to give away at least 5% of their assets annually in order to keep their tax-exempt status. Should they fail to meet this distribution requirement, they are subject to penalties, fines and a possible loss of tax-exempt status.
Donor Control and Reporting Requirements
One reason some donors choose private foundations over DAFs is the level of control they provide. However, this control comes with additional administrative and reporting responsibilities.
- DAFs: Donors recommend grants, but the sponsoring organization has the final authority on distributions.
- Private Foundations: Donors (or their board of directors) have full control over grant distributions, investment decisions, and charitable initiatives as long as they comply with IRS regulations.
Private foundations are required file the IRS Form 990-PF every year. This form has information about donations, investment income, and costs. DAFs, on the other hand, don’t require donors to file their own taxes because the sponsoring organization handles the tax filing as an entity by including all of its sponsored DAFs.
Excise Taxes and Administrative Costs
Another important consideration for donors comparing DAFs and private foundations is the impact of excise taxes and operational expenses.
- DAFs: No excise taxes apply, and administrative costs are typically low because sponsoring organizations handle legal compliance, investment management, recordkeeping and tax filing.
- Private Foundations: Subject to a 1.39% excise tax on net investment income, along with potential legal and administrative costs, which can be significant depending on the foundation’s size.
This makes DAFs a more cost-effective option for donors who want a streamlined charitable giving experience without the overhead of running a foundation.
Choosing Between a DAF and a Private Foundation
Ultimately, the best choice between a DAF and a private foundation depends on the donor’s goals, tax situation, types of assets to be donated and desired level of involvement.
- If a donor prioritizes immediate tax deductions, low administrative burdens, and flexibility in grant timing, a DAF is the better option.
- If a donor values complete direction over grantmaking, investment management, and long-term legacy building, a private foundation may be the right fit, despite the additional administrative requirements.
Some donors choose to use both vehicles in their philanthropic strategies—establishing a private foundation for long-term initiatives while utilizing a DAF for more immediate, flexible giving.
Making an Informed Choice for Your Charitable Giving
To figure out how DAFs and private foundations affect your taxes, you need to think carefully about your financial goals, your charitable vision, and the amount of involvement you would like. If your main goals are to maximize tax benefits and have the least amount of paperwork to do, a DAF is a simple way to get those benefits. However, if you want full, unmitigated direction over gifts, investments, and building a legacy, a private foundation is the best way to make a lasting impact, even though the costs can be restrictive and the regulations can be imposing.
In the end, the two in tandem can be a formidable choice to give the maximum flexibility and tax benefits for your donations, along with the most family direction possible.
