Family philanthropy: Tips on private foundation vs. donor advised fund

In contrast, a donor advised fund is much easier to establish. The donor contacts a sponsoring organization (which already has a 501(c)(3) designation) and completes their required paperwork to initiate the creation of their donor advised fund. Contribution can usually then be received shortly thereafter. This is normally a much more expeditious process as compared to the formation of a private foundation. A DAF may only take a day or two to create and receive contributions, verses a PF, where it may take several months to be in the same position.

 Administrative considerations

Once the charitable mechanism has been established, both a PF and a DAF require ongoing administrative functions to maintain the contributed funds. There are clearly less administrative responsibilities for the donor family with the DAF, as the managing charity handles most of the administration responsibilities. Private foundations clearly have ongoing administrative tasks, including maintaining accounting records, managing investment assets, ensuring annual federal and state tax filings are made, keeping board minutes, and administering their grant programs.

With a donor advised fund, the donor typically only makes grant recommendations to the sponsoring organization, who then acts on those recommendations. The responsibility to manage the investible funds typically rests with the sponsoring organization, not the donor family.

Tax implications to donor

Donations to a private foundation or to a donor advised fund are both tax deductible. However, the resulting tax deductibility to the donor family varies between these two.

The donation of cash and publicly-traded securities results in the same tax deduction for contributions to a private foundation and a donor advised fund. The tax deduction resulting from donated cash and publicly-traded securities is their fair market value (FMV) at the date of the gift.

The tax deduction resulting from closely-held stock donated to a DAF is also its fair market value at the date of the gift. Please note that typically an appraisal of some type is required to substantiate the FMV in such situations. However, the tax deduction resulting from donated closely-held stock to most private foundations is limited to only the donor’s cost basis.

An individual taxpayer’s charitable tax deduction limitations are also different between a PF and a DAF. An individual’s charitable deduction limitation on cash gifts to a private foundation is 30% of their adjusted gross income (AGI). This is in contrast to the 60% of AGI limitation for cash contributions to a donor advised fund. Furthermore, an individual’s charitable deduction limitation for gifts of publicly traded securities is 20% of AGI for contributions to a private foundation and 30% of AGI for contributions made to a donor advised fund.

Other matters

There are also tax considerations to be evaluated in the administration of these two charitable vehicles. Private foundations have certain annual distribution requirements and are liable for tax on annual investment income. The IRS requires that private foundations annually distribute 5% of net asset value, regardless of earnings. Failure to comply with this requirement results in an excise tax being imposed on the private foundation. Donor advised funds are not subject to this annual distribution requirement. In addition, private foundations are liable for a 1% - 2% excise tax on annual net investment income. This excise tax does not apply to donor advised funds.

Privacy concerns are another consideration in determining the appropriate charitable vehicle to achieve the family’s philanthropic desires. Donor advised funds lend themselves to more anonymity from the broader public. Private foundations have an annual income tax filing requirement (Form 990-PF). This return is open to public inspection. Form 990-PF return filing contains various information about the donor and his/her contributions to the entity. DAFs file Form 990 which is also open to public inspection. However, the Form 990 doesn’t require donor information be disclosed. Further, grants can be made from a DAF without disclosing the donor.

Consider all factors

There are many factors to consider when determining which charitable vehicle is best suited for achieving the donor family’s desires. It is critical to contemplate all factors – philanthropic goals, administrative considerations, tax implications – before deciding which charitable vehicle is best suited to assist donor families in successfully fulfilling their philanthropic goals.

This article originally published on the Houston Business Journal.