Donor-Advised Funds in the Age of Tax Reform
As we return from summer vacations and enter the last few months of the year, many individuals will meet with their professional advisers to discuss tax reduction planning, wealth management goals, and estate plans. We know that charitable giving is often an important element of these conversations, especially in the season of giving as many of us revisit and act on our philanthropy. This year-end brings new considerations for the good-hearted generous person as a result of last year’s tax reform.
At the same time, the nonprofit community is closely monitoring the impact of recent tax reform on donor generosity. The Tax Cuts and Jobs Act, primarily effective for years beginning in 2018, doubled the standard deduction for individuals, thereby greatly reducing the number of donors who itemize deductions on their income tax returns. The financial reward for charitable giving is given to the taxpayer through itemized deductions (i.e. the charitable deduction), so there is some concern that removing the incentive of the charitable deduction may reduce annual giving. Studies released at the end of 2017 showed some scary numbers, such as a study by the Tax Policy Center, who stated that charities could see a staggering loss of $12 - $20 billion in contributions annually, equal to 6 percent of all individual giving on the low end.
At the Lehigh Valley Community Foundation, we do not believe that we will see as steep of a drop in giving as some of these tax studies had inferred. We know that an innate desire to do good exists on the part of philanthropists—we call it the “giving gene”—so philanthropy will continue in some way, with or without a financial incentive to do so. Studies of donor wants and preferences show that a reduced tax obligation is not the main driver of individual giving. With that said, a lower income tax bill is certainly an added benefit to both the donor and the nonprofit, and it can be a call to action for the donor on an annual basis.
It is in this context of a new tax environment coupled with the desire to preserve individual philanthropy that we at the Community Foundation have seen a resurgence of an approach to giving that we call “donation bunching.”
Many professional advisers (accountants, attorneys, wealth managers, and others who work with clients’ money) have informed us that they are exploring “donation bunching” with their clients as a way to reduce income tax bills while preserving the current levels of charitable giving. The donor-advised fund, or “DAF,” is a charitable giving tool that is popular in this tax strategy. A DAF separates the tax decision from the giving decision. Here’s how it works: Ms. Generous makes a tax-deductible donation, let’s say $50,000, to a donor-advised fund now to exceed the newly increased standard deduction, therefore causing her to itemize deductions and reduce her tax bill as a direct result of the donation. Ms. Generous then recommends grants from the donor-advised fund to nonprofits of her choice over a period of time, say $10,000 per year over 5 years. She does not get a tax deduction for these grants because the initial $50,000 gift to her donor-advised fund allowed her to receive that deduction upfront. Ms. Generous instead takes the standard deduction during these years. Ms. Generous is thereby “bunching” the tax deduction of donations into a single tax year—the year the gift was made to the donor-advised fund—while maintaining her level of support to nonprofits. An added benefit of a donor-advised fund is the ability to accept gifts of appreciated securities, which are particularly popular in this market environment.
The charitable deduction is one of the few itemized deductions that individuals can control, and even increase with joy! Compare this to your real estate tax bill or your mortgage interest—one can quickly understand why Ms. Generous and her adviser would focus on charitable giving and a donor-advised fund as a tax reduction strategy.
As we approach this upcoming season of giving, we encourage you to continue to give to the causes that you care about—the community relies on the generosity of its residents regardless of tax law. But, if you find yourself in your accountant’s office, discussing the need to reduce your tax obligations, remember “donation bunching” and the power of a donor-advised fund at your local community foundation. See the article online at Network Magazine.
ASK ERIKA | Ask me how the Community Foundation can help you establish a donor-advised fund and maximize your impact for improving the quality of life in the Lehigh Valley.
Erika Riddle Petrozelli, CPA
Director of Donor Services
840 West Hamilton Street, Suite 310, Allentown, PA 18101
610 351-5353 Ext. 13 | Erika@lvcfoundation.org