Wednesday, October 10, 2018
The changes made by the Tax Cuts and Jobs Act (TCJA) for tax years beginning after 2017 could have a significant impact on charitable giving. Because of changes made by the TCJA, it is now less likely that any particular taxpayer will itemize deductions. Without itemizing, the tax benefit of making charitable deductions will not be realized. This has raised concerns by many charities.
Are there any tax planning strategies that can be utilized to still get the tax benefit from charitable deductions? There might be. One of those strategies is the donor-advised fund.
Using a donor-advised fund for charitable giving post-TCJA – that’s the topic of today’s post.
A taxpayer gets the tax benefit of charitable deductions by claiming them on Schedule A and itemizing deductions. However, the TCJA eliminates (through 2025) the combined personal exemption and standard deduction and replaces them with a higher standard deduction ($12,000 for a single filer; $24,000 for a couple filing as married filing jointly). The TCJA also either limits (e.g., $10,000 limit on state and local taxes) or eliminates other itemized deductions. As a result, it is now less likely that a taxpayer will have Schedule A deductions that exceed the $12,000 or $24,000 amount. Without itemizing, the tax benefit of charitable deductions is lost. This is likely to be particularly the case for lower and middle-income taxpayers.
One strategy to restore the tax benefit of charitable giving is to bundle two years (or more) of gifts into a single tax year. Doing so can cause the total amount of itemized deductions to exceed the standard deduction threshold. Of course, this strategy results in the donor’s charities receiving a nothing in one year (or multiple years) until the donation year occurs.
A better approach than simple bundling (or bunching) of gifts might be to contribute assets to a donor-advised fund. It’s a concept similar to that of bundling, but by means of a vehicle that provides structure to the bundling concept, with greater tax advantages. A donor-advised fund is viewed as a rather simple charitable giving tool that is versatile and affordable. What it involves is the contribution of property to a separate fund that a public charity maintains. That public charity is called the “sponsoring organization.” The donor retains advisory input with respect to the distribution or investment of the amounts held in the fund. The sponsoring organization, however, owns and controls the property contributed to the fund, and is free to accept or reject the donor’s advice.
While the concept of a donor-advised fund has been around for over 80 years, donor-advised funds really weren’t that visible until the 1980s. Today, they account for approximately 4-5 percent of charitable giving in the United States. Estimates are that over $150 billion has been accumulated in donor advised funds over the years. Because of their flexibility, ease in creating, and the ability of donors to select from pre-approved investments, donor advised funds outnumber other type of charitable giving vehicles, including the combined value included in charitable remainder trusts, charitable remainder annuity trusts, charitable lead trusts, pooled income funds and private foundations.
Mechanics. The structure of the transaction involves the taxpayer making an irrevocable contribution of personal assets to a donor-advised fund account. The contribution is tax deductible. Thus, the donor gets a tax deduction in the year of the contribution to the fund, and the funds can be distributed to charities over multiple years.
The donor also selects the fund advisors (and any successors) as well as the charitable beneficiaries (such as a public charity or community foundation). The amount in the fund account is invested and any fund earnings grow tax-free. The donor also retains the ability to recommend gifts from the account to qualified charities along with the fund advisors. The donor cannot, however, have the power to select distributes or decide the timing or amounts of distributions from the fund. The donor serves in a mere advisory role as to selecting distributees, and the timing and amount of distributions. If the donor retains control over the assets or the income the transaction could end up in the crosshairs of the IRS, with the fund’s tax-exempt status denied. See, I.R. News Release 2006-25, Feb. 7, 2006; New Dynamics Foundation v. United States, 70 Fed. Cl. 782 (2006).
No time limitations apply concerning when the fund assets must be distributed, but the timing of distributions is discretionary with the donor and the fund advisors.
When highly appreciated assets are donated to a donor advised fund, the donor’s overall tax liability can be reduced, capital gain tax eliminated, and a charity can benefit from a relatively larger donation. For taxpayer’s that are retiring, or have a high-income year, a donor advised fund might be a particularly good tax strategy. In addition, a donor advised fund can be of greater benefit because the TCJA increases the income-based percentage limit on charitable donations from 50 percent of adjusted gross income (AGI) to 60 percent of AGI for cash charitable contributions to qualified charities made in any tax year beginning after 2017 and before 2026. The percentage is 30 percent of AGI for gifts of appreciated securities, mutual funds, real estate and other assets. Any excess contributed amount of cash may be carried forward for five years. I.R.C. §170(b)(1)(G)(ii).
Donor-advised funds are not cost-free. It is common for a fund to charge an administrative fee in the range of 1 percent annually. That’s in addition to any fees that might apply to assets (such as mutual funds) that are contributed to the donor advised fund. Also, the fund might charge a fee for every charitable donation made from the fund. That’s likely to be the case for foreign charities.
In addition, as noted above, the donor can only recommend the charities to be benefited by gifts from the fund. For example, in 2011 the Nevada Supreme Court addressed the issue of what rights a donor to a donor advised fund has in recommending gifts from the fund. In Styles v. Friends of Fiji, No. 51642, 2011 Nev. Unpub. LEXIS 1128 (Nev. Sup. Ct. Feb. 8, 2011), the sponsoring charity of the donor-advised fund used the funds in a manner other than what the donor recommended by completely ignoring the donor’s wishes. The court found that to be a breach of the duty of good faith and fair dealing by the fund advisors. But, the court determined that the donor didn’t have a remedy because he had lost control over his contributed assets and funds based on the agreement he had signed at the time of the contribution to the donor-advised fund. As a result, the directors of the organization that sponsored the donor-advised fund could use the funds in any manner that they wished. That included paying themselves substantial compensation, paying legal fees to battle the donor in court, and sponsoring celebrity golf tournaments.
Also, an excise tax on the sponsoring organization applies if the sponsoring organization makes certain distributions from the fund that don’t satisfy a defined charitable purpose. I.R.C. §4966. Likewise, an excise tax applies on certain distributions from a fund that provide more than an incidental benefit to a donor, a donor-advisor, or related persons. I.R.C. §4967.
The TCJA changes the landscape (at least temporarily) for charitable giving for many taxpayers. To get the maximum tax benefit from charitable gifts, many taxpayers may need to utilize other strategies. One of those might include the use of the donor-advised fund. If structured properly, the donor-advised fund can be a good tool. However, there are potential downsides. In any event, competent tax counsel should be sought to assist in the proper structuring of the transaction.