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Minimize Taxes and Maximize Impact with Donor Advised Funds | Olson Wealth Group
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Minimize Taxes and Maximize Impact with Donor Advised Funds

Recent changes to the tax code will affect every American.  Besides the modifications to tax rates and income tax brackets, the most important revision may be the near doubling of the standard deduction up to $12,000 for single taxpayers and $24,000 for joint filers.  In recent years, around 30% of personal income taxpayers have elected to itemize deductions on Schedule A.  For most of them, these deductions have typically included mortgage interest, state and local taxes, and charitable contributions.  However, for the vast majority of filers, the increased standard deduction and new limitations on the deductibility of state and local taxes will negate the benefits of itemizing, and it is estimated that less than 10% will continue to do so.  As a result, the tax benefits which motivate many people to engage in charitable giving will no longer exist.  According to the nonpartisan Tax Policy Center, this change could reduce donations to charitable institutions by as much as $20 billion per year.

Because of the higher thresholds for electing to itemize their deductions, the strategy employed by many individuals to spread their charitable contributions evenly over several years may no longer be viable.  But there are strategies to ‘bunch’ charitable contributions in such a way as to itemize all charitable deductions in one year, reducing one’s tax liability while promoting their vision for a better world.  (As always, we encourage you to consult with your personal tax advisor and qualified financial planner before undertaking any tax management strategy.)

But what if, for whatever reason, you do not want your charitable beneficiary to receive several years’ worth of donations all at once?  One possible approach involves the set-up of a donor-advised fund (DAF).  Until recently almost exclusively used by individuals falling into the top income tiers, DAFs are experiencing a post-tax reform boom in growth as they are now becoming more widely adopted by advisors to clients across the socioeconomic spectrum.

With a DAF, you contribute a lump sum of cash or securities (optimally those which have seen a large amount of capital appreciation) to establish the fund with any of a number of nonprofit organizations and investment institutions which offer them.  The fund then takes on the responsibility for distributing the assets you contributed (along with any income or capital appreciation they generate) over several years to charitable organizations.  While DAFs are not technically required to follow their donors’ ‘advice’, as a practical matter they all have a very strong incentive to do so; a DAF which ignores the wishes of its donors will likely be short-lived.  As long as the ultimate recipient is a qualified charitable organization, the questions of ‘Where?’, ‘When?’, and ‘How Much?’ are, for all intents and purposes, dictated by you the donor.

Donor-advised funds are relatively inexpensive to set up and maintain.  Securities donated to the DAF can be held in the fund to allow them to continue to grow and produce income, or they can be sold within the DAF with no capital gains tax liability to the donor or to the fund.  The best part is that you get to take a charitable deduction for the value of the assets you donate to the fund in the year you make that donation, regardless of when the charities themselves receive their distributions.

The following two examples show how this plays out over time:

EXAMPLE 1:  John and Jane are a charitably-inclined married couple in a high-tax state, both in their 50s, who file a joint tax return.  They have two dependent children under 16 and their home is paid off, so they have no mortgage interest.  Their income and deductions for 2017 are as follows:

Adjusted gross income (AGI):        $150,000

State and local taxes paid:              $15,000

Charitable contributions:                $12,000 cash

Based on the old tax laws, their 2017 tax liability is calculated as follows:

  •  Itemized deductions = 27k; standard deduction $12,700 (couple elects to itemize)
  •  AGI (150k) less itemized deductions (27k) less exemptions ($16,200) = $106,800 taxable income
  •  2017 federal income tax liability (from table) = $18,178 less 2k child tax credit = $16,178 tax

Assuming their income, deductions, and other factors impacting their taxes remain exactly the same for 2018, their tax liability in that year after incorporating the effects of tax reform would be:

  •  Itemized deductions = 22k (state and local taxes capped at 10k); standard deduction ($24,000)                                         (elect to used standard deduction)
  •  AGI (150k) less standard deduction (24k) (exemptions repealed) = $126,000 taxable income
  •  2018 federal income tax liability (from table) = $19,599 less 4k child tax credit = $15,599 tax

This shows that the Tax Cuts and Jobs Act (TCJA) is mildly beneficial to John and Jane.  While they lose their personal exemptions and part of their state and local tax deductions, they get the benefit of the higher standard deduction, higher child tax credit, and lower tax rates.  What is also apparent, however, is that in 2018 John and Jane receive no tax benefit whatsoever from their quite generous charitable contributions.  While their $12,000 in donations provided them with $2,550 in tax benefits in 2017, that same donation amount yielded no tax benefit in 2018.  In fact, they could have donated nothing to charity in 2018 and paid the exact same amount in federal taxes.  It is small wonder that charitable organizations are concerned about future funding sources.

What could John and Jane have done differently in 2018?  I would like to point out that they are good candidates for a donor-advised fund.  If we make the assumption that they have sufficient liquid assets to accelerate and ‘bunch’ together five years of their charitable contributions (5 x $12,000 = $60,000) to a DAF all in the first year,  here is what their 2018 taxes could look like:

  • Itemized deductions = 70k (state and local taxes capped at 10k; plus 60k charitable deduction);
    standard deduction ($24,000)  ( couple elects to itemize)
  • AGI (150k) less itemized deductions (70k) (exemptions repealed) = $80,000 taxable income
  • 2018 federal income tax liability (from table) = $9,479 less 4k child tax credit = $5,479 tax

The fact that they can realize over $10,000 in tax savings all in the first year (using funds that they had likely set aside for future contributions anyway) provides a strong justification for going the DAF route.  Under the new rules, in any given year they can deduct charitable contributions made in cash up to 60% of their AGI (in their case $90,000; in 2017 and prior years the limitation was 50% of AGI).

Assuming their income and tax situation is somewhat static over the ensuing four years, the fact that they will have no charitable contributions to deduct in those years will have no impact on their tax situation.  And they have the ability to advise the DAF to distribute the cash when and to whom they wish over that time period and beyond.

EXAMPLE 2:  Assume the same facts as above, only now instead of cash John and Jane wish to donate shares of stock in various companies which they purchased several years ago for only $10,000 but are now worth $60,000.  If they elect to sell the shares and give the proceeds to charity, they would incur a 15% capital gains tax on the $50,000 of appreciation ($7,500).  If they place these securities in the DAF, they can get a charitable deduction for the current market value of the shares, and also allow their value to grow tax-free within the fund.  Note, however, that for capital gain property such as this there is a 30% AGI limitation for deductibility in any one year.   (The same 30% was in effect in 2017 and prior years as well).  So John and Jane would only be able to deduct $45,000 of appreciated stock donated in 2018.  For them and others trying to decide between gifting appreciated assets versus cash the benefit of avoiding capital gains taxation must be weighed against this limitation on deductibility.

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As a client of Olson Wealth Group, we are able to provide you with access to a number of different donor-advised fund platforms.  In addition, our comprehensive planning model, which analyzes your unique financial situation in its entirety, allows us to explore how your legacy goals fit into your overall financial picture, and to design strategies which complement other parts of your plan:  taxes, retirement income, investment returns, and more.  Our objective is to provide you with a strategy, not a series of piecemeal products.

Olson Wealth Group is a full-service wealth management firm that leverage capital in all forms to support investors who wish to align their values with their investments to solve complex social and environmental problems.  Specializing in hands-on experience and high-level oversight for smaller ($2-20M) family foundations, we provide training and guidance in fiduciary responsibility including cost management, asset class selection, and performance/allocation measurement. For more information, please visit OlsonWealthGroup.com

These are hypothetical situations based on real life examples.

Names and circumstances have been changed.

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual.

To determine which investments or strategies may be appropriate for you, consult your financial advisor prior to investing.

This information is not intended to be a substitute for specific individualized tax advice. We suggest that you discuss your specific tax issues with a qualified tax advisor.

Securities and advisory services offered through LPL Financial, a Registered Investment Advisor, Member FINRA/SIPC. Registered states include: AR, AZ, CA, CO, FL,GA, IA, IL, IN, MA, MD, ME, MI, MN, MO, MT, NC, ND, NV, NY, OH, OR, PA, SC, SD, TX, VA, WA, WI, WY. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and may not be invested into directly.