Tax Benefits and Pitfalls of Donor-Advised Funds in 2024

Donor-advised funds (DAFs) have long been favored by philanthropically minded individuals for their flexibility, tax advantages, and simplicity in charitable giving. However, recent scrutiny from lawmakers has cast a spotlight on DAFs, particularly regarding concerns about the timeliness of disbursements to charities. In light of potential reforms, understanding both the benefits and the potential pitfalls of DAFs is essential for donors seeking to maximize their impact and tax savings. In this article, we’ll explore how DAFs operate, their tax benefits, and key strategies for staying ahead of possible regulatory changes.

Overview of Donor-Advised Funds (DAFs)

A donor-advised fund is a charitable investment account that allows individuals to make irrevocable contributions to a sponsoring organization—typically a public charity or financial institution’s philanthropic division—while retaining the ability to advise on future grants to charitable organizations. This structure provides a streamlined way to give, allowing donors to set aside assets for charitable purposes without being tied to immediate disbursement requirements.

Tax Benefits of DAFs

For individuals, families, and businesses seeking tax-efficient charitable giving, DAFs provide significant advantages. Here’s how DAFs can help donors maximize tax savings while facilitating long-term philanthropy:

1. Immediate Charitable Deduction

When donors contribute to a DAF, they receive an immediate tax deduction, even if the funds aren’t disbursed to charities right away. This deduction applies for the tax year in which the contribution was made, allowing donors to take advantage of tax benefits when it’s most beneficial.

• Cash Contributions: Donors can deduct up to 60% of their adjusted gross income (AGI) for cash contributions to DAFs.
• Appreciated Securities and Non-Cash Assets: For non-cash contributions, such as stocks, real estate, or cryptocurrency, donors can deduct the fair market value up to 30% of AGI, avoiding capital gains tax on appreciated assets.

1. Growth Potential Through Investment

After contributing to a DAF, donors can invest the assets within the fund, allowing them to grow tax-free. By investing DAF contributions, donors can potentially increase their charitable impact over time, with the additional value ultimately benefiting the recipient charities.

• Tax-Free Growth: Unlike a taxable brokerage account, any investment gains within a DAF are not subject to capital gains tax, enabling the fund’s assets to grow more quickly and with greater compounding potential.
• Strategic Giving Opportunities: Donors can “time” grants to align with personal or family financial goals, offering more flexibility in charitable giving while maximizing tax benefits.

1. Simplicity and Flexibility

DAFs provide a simple and flexible alternative to private foundations, with fewer administrative burdens and lower costs. DAFs are particularly beneficial for individuals who want to consolidate their giving under a single account without the ongoing compliance requirements of a foundation.

• Low Administrative Burden: DAF sponsors handle all administrative work, including record-keeping, compliance, and grant-making logistics, reducing the effort required of the donor.
• Anonymity Options: Donors who wish to keep their contributions or disbursements private can do so through DAFs, as many sponsors offer anonymous grant options—a benefit not available with private foundations.

Potential Pitfalls and Legislative Scrutiny

Despite these advantages, DAFs have come under scrutiny in recent years, with lawmakers raising concerns about delayed charitable disbursements and the lack of transparency regarding funds earmarked for charity. Potential regulatory changes in 2024 and beyond could impose new requirements on DAFs, making it essential for donors to stay informed and proactive.

1. Concerns About “Warehousing” of Funds

One of the primary criticisms of DAFs is that funds can remain in accounts indefinitely without a requirement to be disbursed to charitable organizations. This delay—sometimes referred to as “warehousing”—has led to calls for reform, particularly by organizations and lawmakers advocating for minimum disbursement requirements similar to those for private foundations, which must distribute 5% of their assets annually.

• Potential Reforms: Some proposed reforms would require DAFs to distribute a certain percentage of their funds each year or face penalties, while others suggest a timeline (e.g., 15 years) within which funds must be fully granted.
• Impact on Donors: Donors who are accustomed to the flexibility of DAFs could see limitations on how long they can defer charitable giving. Planning to make periodic disbursements could help donors remain compliant with any future requirements.

1. Loss of Donor Control Over Final Disbursements

While DAFs allow donors to advise on grants, ultimate control rests with the sponsoring organization. This structure can lead to potential conflicts if the donor’s intentions don’t align with the sponsor’s policies or priorities, particularly when dealing with family or generational shifts in philanthropic goals.

• Beneficiary Conflicts: Without clear, documented intentions, successor advisors (e.g., children or heirs) could face challenges when attempting to direct funds according to the original donor’s wishes.
• Planning for Successor Advisors: Naming successor advisors with clear guidance and aligning the DAF’s mission with personal or family goals can help mitigate the risk of unwanted deviations from the donor’s intentions.

1. Restrictions on Political or Religious Giving

Many DAF sponsors have restrictions on political donations, lobbying efforts, or donations to specific types of religious institutions, which can limit the scope of grants. Donors with strong interests in specific causes or institutions should confirm that their DAF sponsor’s policies align with their intentions before making a commitment.

• Policy Review: Donors should review DAF policies carefully to ensure alignment with their giving priorities and consult legal and tax advisors if necessary to determine alternative charitable structures if their goals don’t match DAF limitations.

Best Practices for Maximizing the Benefits of DAFs in 2024

With the potential for regulatory changes on the horizon, donors can take proactive steps to optimize their DAF contributions and stay ahead of compliance issues.

1. Plan for Regular, Strategic Disbursements

Given potential reforms, donors may want to consider adopting a disbursement plan that meets anticipated minimum distribution requirements. Regular disbursements can help ensure compliance with future regulations, while also enabling donors to create a meaningful and consistent impact.

• Establish Annual Giving Goals: Setting a targeted annual distribution amount can help maintain steady disbursements to preferred charities while meeting potential future requirements.
• Adjust for Investment Growth: As DAF assets grow, periodically review disbursement plans to maximize impact and avoid accumulating excessive balances.

1. Use Appreciated Assets for Contributions

Contributing appreciated assets—such as stocks, real estate, or other investments—offers a double tax benefit by avoiding capital gains tax and securing a charitable deduction based on the asset’s current value. This strategy allows donors to maximize the size of their contributions without realizing taxable gains.

• Ideal for High-Income Years: Donors anticipating a high-income year can contribute appreciated assets to reduce taxable income while supporting future charitable giving.

1. Document Goals and Appoint Successor Advisors

To ensure that a DAF aligns with the donor’s legacy, it’s important to document philanthropic goals clearly, particularly if successor advisors will eventually take over the fund. Naming successors and providing guidance for specific causes, charities, or goals can help prevent potential conflicts and ensure continuity.

• Family Involvement: Involving family members in DAF planning from the beginning can help align future decisions with the donor’s vision and ensure that the fund’s goals are respected over time.

1. Consider Alternative Charitable Vehicles

For donors with specific goals that don’t align with a DAF’s flexibility or disbursement limitations, exploring alternative structures—such as private foundations, charitable remainder trusts, or direct giving—can provide greater control over contributions while potentially achieving similar tax benefits.

• Private Foundations: While more administratively intensive, private foundations provide donors with complete control over disbursements, asset investments, and administrative policies, making them an ideal choice for high-net-worth individuals with significant philanthropic goals.

Conclusion

Donor-advised funds offer substantial tax benefits and flexibility, making them an appealing option for individuals, families, and businesses with charitable goals. However, with lawmakers scrutinizing the practice of holding assets indefinitely in DAFs, donors should prepare for possible reforms by adopting regular disbursement practices, documenting their philanthropic intentions, and ensuring they maximize their tax benefits within the current framework.

At Durfee Law Group, we believe that thoughtful planning is key to navigating these changes and ensuring that DAFs continue to serve their intended purpose: supporting charitable causes and maximizing philanthropic impact. By understanding the benefits and potential pitfalls of DAFs, donors can make informed decisions that align with both their financial and charitable goals.