In a previous post, I wrote about how to minimize your tax bite on the pending Medtronic-Covidien merger set to come about later this year or in 2015. One of the recommended action items was to consider purchasing a donor-advised fund or charitable trust. To keep things simple, I will comment on donor-advised funds and charitable trusts in separate posts. Below is a brief overview of what a donor-advised fund is and how it may benefit you.
Setting up a charitable trust can be complicated and expensive. Donor-advised funds offer many of the same benefits at a much lower cost. For the charitably inclined with appreciated assets and more limited resources they may make sense.
A donor-advised fund is a separate fund operated by an IRS recognized 501(c)(3) organization. For the official IRS definition, click here.
Once cash or stocks have been donated to the fund, the organization has control over it, but you may be able to direct where the money goes when you die. The other major consideration is that your gift is irrevocable. Once you donate shares of stock or cash to the fund, you can’t get them back.
The benefit with the donor-advised fund is that you avoid capital gains tax on your appreciated stock (Medtronic, for example) and get a tax deduction in the amount of your contribution. For example, if you bought stock for $1 that now trades at $65, the difference is a taxable capital gain. Donating this stock to a donor-advised fund avoids the capital gains tax while also allowing you to write off the entire $65 per share as a charitable contribution.
If you owned 500 shares of the above stock, your capital gains tax could be as high as $4,800 (15% capital gains tax on your $32,000 taxable gain) or more. Donating your shares to the donor-advised fund avoids this tax.
Since the value of your stock is $32,500 ($65 x 500) you would also get to deduct up to $32,5,000 from your taxable income. Assuming you are in the 25% Federal income tax bracket, that saves you another $8,125 (25% of $32,500). Add in your state income taxes and the total income tax savings could be even more. Minnesota residents, for example, could save $2,291 or more depending on their state income tax bracket.
The total tax savings for a Minnesota resident in the 25% Federal and 7.05% state income tax bracket could be as much as $15,201. That’s a big tax savings on a $32,500 asset.
Like all gifts to charity, donor-advised funds avoid estate taxes. If you are a Minnesota resident and have a net worth of greater than $1.2 million you may owe estate tax at the state level. If your net worth is below $5.34 million (double that if you are married), you don’t have an estate tax liability at the Federal level.
There are downsides to donor-advised funds. I have mentioned some already.
- It’s an irrevocable gift to charity. You will never get this money back.
- Your gift of appreciated stock is limited to 30% of your adjusted gross income or AGI. In the examples above, to give $35,000 of stock to a donor-advised fund, your AGI needs to be $116,000 or higher. Cash gifts to a donor advised fund can be as much as 50% of your AGI.
- If you are above certain income levels, your tax deduction may be partially phased out. For married couples who file jointly, these phase outs start at $305,050; for single filers it’s $254,200.
- Not all donor-advised funds are created equally. Do your homework. The IRS warns taxpayers to avoid funds that “appear to have abused the basic concepts underlying donor-advised funds”.
- Contributions are not distributed immediately. This is both a pro and a con. On the one hand you can accumulate assets in a donor-advised fund and grow it over time until you choose to make a gift. For example, maybe you have appreciated stock you would like to donate to charity this year. You just don’t know which one. A donor advised fund lets you wait until you are ready while allowing you to enjoy the tax deduction today. On the other hand, many charitable organizations need revenue now as well as in the future. In this case a direct, immediate gift to your favorite charity may be better.
In general, donor-advised funds can be an easy way for you to give appreciated assets to charity and receive many of the same tax benefits as some of the more complicated estate tax vehicles like charitable trusts or private foundations, but without the expense.
Before you make a decision to contribute to such a fund, carefully weigh all your options and consult your financial advisor and tax professional. If you would like to know more about whether or not a donor-advised fund is right for you, just Ask Mike.
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