Donor-Advised Funds and Tax-Smart Charitable Giving

Greetings!

Tax Planning

This month we will review Donor Advised Funds (DAFs).

Why would you use a DAF?

You are already gifting to your church and/or some type of charitable organization.

What are the tax benefits of a DAF?

You can donate and deduct the market value of your investments that have been held for more than 1 year and a day.

The benefit is that you don't have to realize any gains on the donation, which means you do NOT pay capital gains tax.

Example:

John and Jane are married and in the 37% income tax bracket and are subject to the 20% long term capital gain tax rate - plus the 3.8% net investment income tax rate.

They plan on gifting $50,000 to their church this year from a stock they put $10,000 into 5 years ago that is now worth $50,000.

Their two options are 1.) Sell the stock and donate the cash, or 2.) They could donate the stock directly to the church using a DAF. This hypothetical example is only for illustrative purposes.

1Assumes a cost basis of $10,000, that the investment has been held for more than a year, and that all realized gains are subject to a 20% long-term capital gains tax rate and the 3.8% net investment income tax. The analysis does not take into account any state or local taxes.

2Assumes donor is in the 37% federal income tax bracket and does not take into account any state or local taxes. Certain federal income tax deductions, including the charitable contribution, are available only to taxpayers who itemize deductions and may be subject to reduction for taxpayers with AGI above

certain levels. In addition, deductions for charitable contributions may be limited based on the type of property donated, the type of charity, and the donor's

AGI. For example, deductions for contributions of appreciated property to public charities generally are limited to 30% of the donor's AGI. Excess contributions may be carried forward for up to five years.

Now you might wonder, if you were planning to make charitable donations, why not just donate cash and keep your investments compounding?

You could certainly do that. But here is why you would consider donating the stock:

1. If one particular stock has increased substantially, it may be out of your comfort zone for holding that 1 position and you may want to diversify your investments 2. You may need to rebalance your investments and don't want to sell to trigger any capital gains tax

I think #2 is a potent reason to consider this strategy. Here is why:

Per my prior newsletter in March, I discussed how the US markets have outperformed international over recent history as well as Growth funds have outperformed Value funds.

This has caused an imbalance in portfolios that needs to be addressed. The tricky part is not wanting to sell the funds to rebalance as it would trigger capital gains tax. Now we are addressing this imbalance with new money that is coming into client accounts but this strategy can aid the rebalancing process as well as help those who are not actively adding to their accounts.

Here is what I mean:

Let's say you were ALREADY planning on giving this year, the balance doesn't matter but let's say it's $50,000.

Rather than gifting the $50,000 cash, you gift the $50,000 from the funds we need to sell to rebalance (does NOT trigger a capital gain) then replace the $50,000 of stock you just gifted with a cash contribution to your investment account of $50,000.

We then take that $50,000 and buy into the funds that are under weighted in our portfolio to bring it back into balance.

This solves the question "Why not just donate the cash and keep your investments compounding" because you are donating the fund but then immediately putting cash back into the market to replace the fund that was donated.

It's as if you never left the market and the added benefit is you are "selling" the fund that is high (again no capital gain tax is triggered) and then buying low with the cash that you replaced the fund with.

To be clear, this is only beneficial if you were already planning to donate money. If you had no intentions to donate money there is no advantage to giving away $50,000 to save $20,000 in taxes. You're still out $30,000.