A range of factors need to be considered when deciding whether to use a donor-advised fund or a private foundation to execute a philanthropic set of goals. The author of this article considers the issues that can sway a decision.

This publication regularly covers philanthropy topics, for example the different structures that are used, such as foundations and donor-advised funds. This article from Sean Brady looks at the considerations that arise when choosing charitable vehicles. Brady is a managing director and wealth and fiduciary advisor at Evercore Wealth Management and Evercore Trust Company. The editors are pleased to share these views; the usual editorial disclaimers apply. Email tom.burroughes@wealthbriefing.com and amanda.cheesley@clearviewpublishing.com

Nonprofit organizations in the US hold more than $13.7 trillion in total assets. (1) To put that number in perspective, that’s enough to buy Apple, Nvidia, Microsoft, Meta, and all the bitcoin in the world, with a few billion to spare. Private foundations hold over $1.5 trillion in assets, a number that seems likely to grow as Baby Boomers begin to transfer wealth (2). Total household wealth is also at an all-time high, and many families are giving to the causes that matter to them.

The US tax code significantly incentivizes charitable giving. Families can shelter up to 60 per cent of their income from tax by giving directly to IRS-qualified organizations under section code 501(c)(3) or to qualified charitable vehicles. If the donation exceeds the income threshold in any given year, any unused deduction can be rolled over to offset future income over five years. The tax code also provides for an unlimited charitable deduction at death for estate tax purposes.

The tax benefits of gifting can also be “stacked.” For example, the IRS allows certain public and private assets with a low cost basis to be transferred into charitable vehicles, which can generate a triple tax benefit: 1, no realization of capital gains tax on the sale of the appreciated asset, 2, an income tax deduction for the full fair market value of the gift, and 3, a reduction in the donor’s taxable estate. 

While there are many options for charitable giving (contact your advisor for our thoughts on qualified charitable distributions, charitable lead trusts and charitable remainder trusts) most high net worth families that choose to give use either a donor-advised fund (DAF), or a private foundation (or a combination of the two). Donor-advised funds are a convenient vehicle, as the administrative burden is minimal, the cost is low, and families can recommend gifts to nearly any qualified 501(c)(3) organization. 

In general, private foundations only make sense for families who plan to allocate significant wealth to charity or for those with very specific or complex giving goals involving multiple generations.

The choice between a DAF and a private foundation is personal, as well as practical. Families with moderate or emerging philanthropic goals often start with a DAF, while those seeking to establish a legacy or engage in sophisticated giving gravitate toward private foundations. All families should carefully consider in close consultation with their advisors what assets to gift, how to give, and when to give. 

Which charitable giving vehicle is right for your family? 

Donor-advised funds 
A DAF is an account that is part of a larger charitable giving vehicle maintained by a nonprofit organization such as a community foundation or sponsored by a financial institution. Donors make irrevocable contributions, receive immediate tax benefits, and recommend grants to charities over time. The accounts are usually externally managed and invested in specific investment pool options. Donors receive a tax deduction of 60 per cent of adjusted gross income, or AGI, for gifts of cash and 30 per cent of AGI for gifts of appreciated securities. 

Pros
• Full tax deduction available upon funding the account; 
• Gifting can be anonymous; 
• Lower annual fees and streamlined management; and 
• No required distributions.

Cons
• Gifts are usually restricted to IRS-qualified charities; 
• Less flexibility and control from a giving and investment perspective compared to a private foundation; and 
• Potential changes in tax law – proposals have been made to require minimum distributions or to subject distributions to an excise tax.

When to use
A DAF is often a more flexible and cost-effective option than a private foundation. These vehicles are ideal for families that have a simple strategy of giving directly to 501(c)(3) organizations over time, regardless of the funding amount. A DAF is also appropriate when long-term control over investments or bespoke giving strategies are not critical.

Private foundations
A private foundation is a separate legal entity established and controlled by an individual, family or corporation. It allows for direct involvement in grant making, investment decisions, and broader philanthropic activities. A private foundation is a long-term vehicle for a family to donate through a shared vision, memorialized in a governing document and designed for building a legacy through intergenerational giving. Decision-making authority for grants can be broad and support a wide range of charitable interests. Donors can receive a tax deduction of up to 30 per cent of AGI for gifts of cash and 20 per cent of AGI for gifts of appreciated securities, which is lower than the maximum charitable deduction of 60 per cent. A private foundation is typically best for substantial gifting needs.

Pros
-- Family maintains control of the assets in the foundation; 
-- Immediate income tax deduction; 
-- Few restrictions on spending; and 
-- Assets are legally separate from the founder. 

Cons
-- Higher set-up and maintenance costs with annual filing requirements
-- Gifts are public record
-- Required to distribute at least 5 per cent annually
-- Subject to strict and complex IRS compliance rules 
-- Subject to an excise tax on net investment income

When to use
A private foundation may be the better choice for families who want greater control over their charitable giving and investment decisions. A private foundation is also suitable for those looking to involve family members in the decision-making process by hiring them as a director or staff (subject to strict IRS rules) or to establish a legacy of philanthropy with long-term impact. The benefits must be balanced with the increased administrative and cost burden. 

When to use both
For some families, the best approach is a combination of a DAF and a private foundation.

-- Specialized grant-making: Establish a foundation for complex, large-scale projects while leveraging a DAF for one-off contributions or contributions that don’t fit into the foundation’s gifting strategy.

-- Efficient tax planning: Donors may be able to stack contributions to maximize charitable deductions. For example, donors can gift appreciated securities to the private foundation up to 20 per cent of AGI, contribute 10 per cent of AGI to the private foundation in cash to reach the 30 per cent threshold, then contribute another 30 per cent of AGI in cash to a DAF to reach the 60 per cent maximum deduction. 

-- Managing payout requirements: Newly-formed foundations without clear grant-making criteria or that are unable to make a grant in time can contribute to a DAF to meet the minimum distribution, and then make the grant from the DAF when ready. 

Footnotes

(1) https://www.federalreserve.gov/releases/z1/dataviz/z1/balance_sheet/table/

(2) Source: Board of Governors of the Federal Reserve System (US)