Most people have a cause they care deeply about, whether it’s an educational institution, charity, animal shelter or research organization. And charitable giving is a great way to make a difference and gain potential tax advantages.
Charitable Giving Options
There are a variety of ways to give:
- Cash and noncash donations: The simplest way to donate is to give money directly to charities and organizations either on an annual basis, for a specific event or on behalf of someone or just when the mood strikes. See Annual Gift Limits (see below in this article) for more information on tax deductions.
- Donor-Advised Funds: Let’s say you’re a generous giver. Every year you donate to your alma mater, a local museum, your church or a personal cause. If you find that you’re spending more time doing paperwork and less time focusing on the charities you love, consider a Donor-Advised Fund, or DAF. This can help simplify your charitable giving while making it much more effective.
- Trusts: Trusts are a flexible way to set up the distribution of assets to your beneficiaries, including charities. As the grantor, you’ll assign a trustee, who can distribute assets, even if you become incapacitated or pass away.
- Wills: You can also leave assets to charitable causes in your will. Consult your legal advisor for more information to see if this option is the best for you.
- Endowments: An endowment fund is an invested asset and earnings from the investment are often paid to execute the fund’s stated goals, while the principal assets generally remain untouched. As an endowment fund grows, it can provide ongoing support for the stated cause like a university or favorite cause in perpetuity.
- Volunteering: Of course, giving money isn’t the only way to donate. Volunteering is also a rewarding way to contribute your time to a cause you care about.
On a basic level, a Donor-Advised Fund (DAF) works a bit like a personal fund dedicated to your charitable giving. Instead of donating to multiple charities separately, you put everything into your DAF. Your contributions are eligible for the most favorable tax deductions available, right away. You then draw on your DAF to recommend grants to your favorite charities whenever you want. The organization that manages the fund takes care of all the details and paperwork — they vet the charity to make sure it is legitimate, send out the checks and keep track of all your donations. They'll even provide a year-end statement listing all your contributions so you're ready for tax time.
While you are deciding on the charities you want your Fund to support, your contributions can potentially appreciate in the fund. When you open a DAF, you are prompted to choose an investment approach that works for your charitable giving goals. By thinking more strategically and using a DAF, you can potentially grow your contributions into a more substantial gift and make an even bigger impact further down the road.
Learn more about how a donor-advised fund works.
Investments in DAFs are subject to market risk, including the possible loss of principal.
Benefits to Opening a DAF
Ease and convenience are certainly a draw, but the main incentive to open a DAF is the potential tax benefit. Once you get a better understanding of the way a DAF works, it may help you make a bigger impact on the charities you want to support. Some of the high-level benefits include:
- Minimizing capital gains tax: When you contribute appreciated securities to a DAF, you won’t pay capital gains taxes. If there’s an upturn in the market, you can use your DAF as a savvy tool to put your earnings to work and give even more to the charities you love.
- Growing tax-free: All the contributions you make to a DAF have the potential to grow in the fund. All this growth is tax-free.
- Offsetting a big year: A bonus, inheritance or windfall could potentially put you into a higher tax bracket and you might want to use the DAF to offset your earnings and maximize your potential tax deductions at the time you need it most.
Ways to Maximize Your DAF
If you’re serious about opening a DAF, consider the following tactics and ideas to make it even more impactful:
- Team up and work together: Sometimes the most effective way to make a difference is to work together with people who share your beliefs. Whether you want to support education, clean water or the local museum, a DAF can make it easy to team up and pool resources.
- Memorial giving: You can easily set up a DAF to honor the memory of a loved one. Friends and family can contribute and the funds can be used to support the deceased’s favorite causes.
- Family giving: A DAF can be a way to get your kids involved and pass on your values to a new generation of givers. By encouraging them to recommend grants, they can experience the act of compassion first hand.
- Build a legacy: You can easily set up a DAF to continue beyond your lifetime so that it will continue to support the causes you are passionate about.
Annual Gift Limits
When you claim a tax deduction for donating to a charity, the IRS requires that you substantiate it. The type of proof depends on the amount you contributed and whether it’s cash or noncash property, like securities. Make sure you review the charitable gift substantiation rules before making a charitable contribution. Specific IRS Code details when and how charitable gifts must be documented.3 Failure to get proper records in a timely manner may prevent you from receiving the tax deduction when you file your return.
As always, consult your tax advisor for guidance related to your personal situation. See the table below for a quick overview of the rules. For additional information, visit the IRS page on Charitable Contribution Deadlines.