Those with a charitable heart can end up receiving in return for what they give — at least when it comes to taxes. Several different types of charitable trusts and other initiatives may allow for the potential for reduced taxes in return for charitable giving.
Two of the most common charitable initiatives today are donor-advised funds (DAFs) and private foundations. While both may be effective ways to give to worthy causes and potentially lower your tax bill, they differ significantly. Learning about donor-advised funds vs. private foundations can help you determine which could work for you.
What Are Donor-Advised Funds?
A Donor-Advised Fund (DAF) allows you to make charitable contributions, potentially receive a tax deduction of up to 60% of your adjusted gross income (AGI), and recommend which charities should benefit from your giving. In terms of charitable giving, it can be a cost-effective strategy for those who aren't planning to establish their own tax-exempt, charitable organization.
Gifts given through a DAF can include cash, long-term appreciating securities such as stocks, bonds and mutual funds, real estate, many other types of investments, and even life insurance.
The tax deduction you receive depends on the type of donation you make. For instance, for most cash contributions, the total amount of contributions that can be deducted is 60% of your adjusted gross income (AGI).
Not only will your donations grow tax-free, but you can also control which charities will benefit from your charitable giving as long as the donations are IRS-qualified.
Donating through a DAF helps enable you to create a philanthropic legacy that offers flexibility when recommending grants, can be anonymous and has tax benefits.
What Are Private Foundations?
A tax-exempt organization can be either a public charity or a private foundation. However, a private foundation typically is funded by a family, individual or corporation, and is subject to stricter tax laws, whereas a public charity is often funded by the community and generally have higher donor tax-deductible giving limits.
One of the main advantages of establishing a private foundation is the ability to help create a lifetime legacy and even help employ your family members in the future. A board of directors typically oversees a private foundation and receives charitable contributions, manages investments and makes grant recommendations. One of a private foundation's more tedious obligations is to file its own tax returns, along with performing other administrative reporting.
Like a DAF, a private foundation that qualified as such under applicable law will receive an immediate tax deduction depending on the types of donations it makes. For cash, private foundation contributions are generally limited to 30 percent of your AGI.
Keep in mind that investment income in a private foundation is subject to an excise tax of 1 or 2 percent. Although a private foundation has different obligations and duties, it can help leave a family legacy for many years to come.
Donor-Advised Funds vs. Private Foundations: The Differences
There are subtle differences between DAFs and private foundations. If you're contemplating a decision solely based on time, costs and simplicity, then you might consider opening a DAF. However, if you'd like to help create a long-term family legacy of charitable giving, a private foundation might be the way to go.
If you want to establish a private foundation, consider all the aspects: assembling a board of directors, filing legal and tax requirements, and recommending grants. Also, the tax deductions from private foundations differ from those of a DAF and contributions are calculated differently.
When it comes to charitable giving, be sure to evaluate all of the considerations, benefits and costs to make a thoroughly informed decision. You should also consider consulting with legal, tax, accounting, financial or investment professionals based on your specific situation.
