The CPA Journal

Donor-Advised Funds: A Well-Kept Secret

By Eric Lee Smith

Once referred to as a “poor man’s foundation,” donor-advised funds (DAF) are now recognized as a flexible, affordable alternative to private foundations. A DAF is a charitable asset account that an individual (or family) can establish through a not-for-profit organization and from which grants can be issued to other public charities. Account minimums range from $10,000 to $50,000; subsequent donations can be as small as $1,000. The fund is owned and controlled by the not-for-profit organization that offers it, but the donor retains the ability to recommend where and how the money is distributed.

In the same way mutual funds brought investing in the stock market into the mainstream, charitable investment funds are lowering the barrier to entry for philanthropy. In 2000, according to a survey in the May 2001 Chronicle of Philanthropy, there were more than 37,000 individual accounts containing total assets of $10.2 billion and awarding $1.4 billion in grants.

Using DAFs

The donor can advise on the investment strategy for a DAF account, based on the choices the not-for-profit provides. Typically, the not-for-profit offers at least three choices:

Income. Funds are typically invested in a money market, which generates income with little or no capital gains.
Growth and income. Funds are typically split evenly between money markets and equities. Such funds generate both income and capital gains.
Growth. Funds are typically split 80/20 between equities and cash. These funds primarily generate capital gains, with modest income.

Most DAFs today are sponsored by community foundations, but many large traditional not-for-profit organizations (such as universities) and not-for-profits started for the specific purpose of offering DAFs are starting new funds. Recent examples include offerings from financial services companies such as J.P. Morgan Chase, Credit Suisse First Boston, and Legg Mason.

A DAF allows donors to make future philanthropic grants to charitable organizations while enjoying an immediate income tax deduction—within the donor’s adjusted gross income (AGI) percentage limits—on contributions of cash or appreciated securities. The donor receives a deduction only for the amount of the donation, not for the growth (if any) in the DAF. The DAF accepts contributions and written recommendations thereafter from the donor about gifts the fund will make to specific organizations and in specific amounts.

The individual donor also has the right to designate a contribution as a separate fund established in her family name (e.g., Jane Doe Charitable Fund). While the individual fund is commingled with other similar funds for investment purposes, the donor is provided with periodic statements detailing contributions, fund earnings, expenses, distributions, charges against the fund, and the balance. Typically, funds will incur an annual administration charge (e.g., 1%) determined by their value.

One benefit of DAFs is that taxpayers can avoid the capital gains tax normally due on the sale of securities because the securities have been donated to a tax-exempt organization. Contributions, including direct contributions by the donor in excess of AGI limits, can be carried over and deducted in the succeeding five years.

The Exhibit illustrates the tax and giving advantages of donating appreciated securities. The example assumes a donation of $60,000 in long-term appreciated securities with a cost basis of $20,000. With the DAF, there are no capital gains taxes, the charity receives more money, and the donor receives a larger tax break.

An Emerging Option

Donor-advised funds are currently marketed primarily to the wealthy by community foundations and not-for-profits related to financial services companies. A few large not-for-profits have created their own DAF, and more will soon. Potential donors are becoming increasingly aware of DAFs through the advice of their financial planners, tax advisors, and stockbrokers.

In the near future, DAFs will be embraced by both the affluent—those with a high annual income—and the wealthy—those with a high net worth. More people will discover the benefits of involving their family in true strategic giving. Financial advisors, media coverage, and the marketing efforts of financial services companies will increase the public awareness of DAFs.

In the near future, account minimums should fall dramatically for donors, from their current level ($10,000–50,000) to the level of a typical mutual fund ($1,000–5,000). If current trends continue, most major donors will have a DAF account and many will have more than one through different not-for-profit organizations. Community foundations will continue to grow and expand their DAF marketing efforts. Many large not-for-profits will offer DAFs and smaller not-for-profits will form consortiums that will allow them to offer DAFs.

Eric Lee Smith is founder and managing director of GivingCapital, Inc., in Philadelphia, a developer of charitable investment technologies and giving programs for financial services companies (www.givingcapital.com).

Editor:
Thomas W. Morris
The CPA Journal

This Month | About Us | Archives | Advertise| NYSSCPA

The CPA Journal is broadly recognized as an outstanding, technical-refereed publication aimed at public practitioners, management, educators, and other accounting professionals. It is edited by CPAs for CPAs. Our goal is to provide CPAs and other accounting professionals with the information and news to enable them to be successful accountants, managers, and executives in today's practice environments.

NOT-FOR-PROFIT ORGANIZATIONS