Donor Advised Funds Explained

What are they?

Donor-advised funds are essentially private foundations that individuals set up on behalf of themselves, family, or company. Much as mutual funds make it easy for investors to maintain diversified portfolios without too many hassles, donor-advised funds let anybody establish what would essentially be a Foundation. In other words, they get to run a grant-making philanthropic institution of their own – minus all the red tape they would otherwise require.

Here’s how a donor advised fund works. Individuals transfer money or assets to donor-advised funds. Whenever they like, they contact the fund’s “sponsor” in this case, the Giving Center, and “recommends”  it to, say, give the United Way $500. In the meantime, the rest of the assets not being donated are invested, accruing gains for the charity.

In more, people founding donor-advised funds transfer the money and assets to sponsoring organizations that are registered 501(𝚌)(3)charities. Giving Center is an IRS recognized 501(c)(3) charity that operates across the United States. Like many national charities and community foundations, the Giving Center also sponsors these types of funds. Charities later get donations from the donor-advised funds. Donors, only “advise”the charitable organization with whom they’ve established a donor-advised fund.

Except to the extent specific charitable-purpose limitations are placed on the use of the funds, legally, donors cede control over the funds when they make the initial donation. This feature permits a tax deduction for that tax year, as would be the case with a more traditional charitable donation. However, because sponsoring organizations want donations to keep flowing, they typically heed donors’ subsequent guidance. 

Following donor advice often means making quick and targeted grants to operating charities, sometimes funds sit dormant when donors don’t make any choices. The share of assets annually paid out, varies among the funds. Did you know? One in five donor-advised funds neglects to deliver any money to charities at all.

Who benefits?

Here is the following example with two donors. One donor transfers $200 cash from his salary to a donor-advised fund. The other donor moves stock – an appreciated asset – currently valued at $200 but originally purchased for $10. While both donations are worth $200 to a charity, the donor with the stock reaps a bigger tax break at the time of the transfer. That is, the cash donor gets a $200 deduction but still must claim that $200 in salary as income. The stock donor gets to deduct the $200 gift after claiming only $10 as income – leaving out the stock’s $190 gain.

In other words, moving such assets from their portfolios to donor-advised funds lets donors secure a tax advantage now with investments that have grown more valuable while postponing decisions about what to do with that money until later.

Despite the appearance of an unfair windfall for some privileged taxpayers, some experts have argued that the tax benefits for donors are overstated. John R. Brooks, a Georgetown University Law Center professor, even argues that many donors could fare better by waiting and giving directly to the charities of their choice when they are ready to do so.

You only give once – for tax purposes

There’s another problem with these donor-advised funds. With typical donations, money moves immediately into an operating charity’s coffers, constituting an unconditional gift for tax purposes. With donor-advised funds, there’s a time lag before the charitable institutions get a boost. Can these still be called gifts?

The IRS says yes, based on the fact that the sponsoring organization is technically a charity. It, not the donor, technically controls the funds.

Yet many experts don’t agree. We often hear people refer to donors to a donor-advised fund as its “owners.” Donors, in fact, are often praised when distributions from their funds support operating charities, as happened when Facebook founder Mark Zuckerberg and his wife Priscilla Chan’s donor-advised fund gave $25 million to the CDC Foundation to fight Ebola. 

Sponsoring organizations going their own way rather than heeding donor advice is a rare exception. That contradicts the notion that the initial donation is truly an unconditional gift.

Do donor-advised funds spur more giving?

Some experts who tout the rapid growth of donor-advised funds say this relatively new philanthropic arrangement democratizes giving. They also say that the potential downsides have not come to fruition and that donor-advised funds could bolster overall giving.

However, the data suggest otherwise. Total giving in the U.S. has either flatlined, relative to the size of the economy, or scored modest gains, largely following stock market growth over the past 40 years. There’s no evidence that the rise of donor-advised funds has increased the volume of money supporting charities overall.

Further, the groups that get the most grants from donor-advised funds are often among the country’s largest charities. Giving Center already has easy avenues through which donors can give, this suggests that donor-advised funds play more of an intermediary role rather than spurring new giving.

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