Donor advised funds

What Is Donor Advised Funds?

Donor advised funds (DAFs) are charitable giving accounts established at a sponsoring public charity. Within the broader category of philanthropy and charitable giving, DAFs offer a flexible and tax-efficient way for individuals, families, and corporations to support qualified charitable organizations. Donors contribute cash, securities, or other appreciated assets to the fund, receive an immediate tax deduction, and then recommend grants from the fund to their preferred charities over time⁴³. While the sponsoring organization legally controls the assets once contributed, the donor retains advisory privileges regarding how the funds are invested and distributed.

History and Origin

The concept of donor advised funds originated in the United States in the 1930s, with the New York Community Trust establishing the first such fund in 1931⁴². Initially, these funds were primarily offered by community foundations. Their usage and popularity grew significantly after the Tax Reform Act of 1969, which introduced regulatory distinctions between private foundations and public charities, making DAFs a more attractive alternative for some donors⁴⁰, ⁴¹. The 1990s saw a further surge in their adoption, partly due to the approval of commercial providers by the IRS³⁹. The Pension Protection Act of 2006 provided additional clarity and formal recognition of donor advised funds within the Internal Revenue Code, leading to new requirements and guidance for these charitable vehicles³⁷, ³⁸.

Key Takeaways

• Donor advised funds provide an immediate tax deduction upon contribution, even if grants to charities are made later³⁶.
• Donors relinquish legal ownership of contributed assets but retain advisory privileges over grant recommendations and investment strategies³⁵.
• DAFs are administered by a sponsoring public charity, which handles the administrative and reporting burdens³⁴.
• Contributions can consist of various asset types, including cash and appreciated securities, which can offer significant tax advantages³², ³³.
• Unlike private foundations, donor advised funds typically do not have a mandatory annual payout requirement for distributions to charities, though some sponsoring organizations may have internal guidelines³⁰, ³¹.

Interpreting the Donor Advised Funds

Donor advised funds are interpreted as a powerful tool for strategic financial planning and philanthropy. For donors, they decouple the timing of the tax benefit from the timing of the charitable grant, allowing for more flexible giving. This means a donor can make a large charitable contribution in a high-income year to maximize their immediate tax deduction, and then distribute the funds to various charities over several years²⁹. From the perspective of charitable organizations, donor advised funds represent a significant and growing source of funding. According to a 2024 report, grants from DAFs to charitable organizations totaled $54.77 billion in 2023²⁸.

Hypothetical Example

Consider an individual, Sarah, who has a highly appreciated stock portfolio and wishes to make a substantial charitable donation without immediately deciding on all the recipient charities.

1. Contribution: Sarah donates shares of a stock valued at $100,000, which she purchased years ago for $10,000, into a donor advised fund sponsored by a public charity.
2. Tax Benefits: Upon contributing the stock, Sarah receives an immediate income tax deduction for the fair market value of the shares (up to certain adjusted gross income limits) and avoids paying capital gains tax on the appreciated value of the stock²⁶, ²⁷.
3. Investment: The sponsoring organization invests the funds, and Sarah can recommend an investment strategy for her account. Over time, the $100,000 grows to $110,000 through investment gains.
4. Grantmaking: A year later, Sarah recommends a $25,000 grant to her alma mater and a $15,000 grant to a local animal shelter. The sponsoring organization approves and disburses these grants. Sarah can continue to recommend grants from the remaining balance of her donor advised fund at her leisure, with the fund continuing to grow and generate more money for future charitable giving.

Practical Applications

Donor advised funds are widely applied across various areas of charitable giving and wealth management:

• Lump-Sum Giving: DAFs are often used by donors who experience a liquidity event, such as the sale of a business or vesting of significant equity compensation, enabling them to make a large charitable contribution and receive an immediate tax benefit²⁵.
• Estate Planning: DAFs can be incorporated into estate planning strategies to manage post-mortem charitable giving, providing a flexible alternative to establishing new charitable entities upon death²⁴.
• Gifting Complex Assets: They offer a simplified way to donate non-cash or complex assets like real estate, privately held stock, or cryptocurrency, which can be challenging to contribute directly to charities²², ²³. The sponsoring organization handles the asset conversion and administration.
• Anonymity: Donors can choose to remain anonymous when grants are made from their donor advised fund to recipient charities, offering privacy and discretion that is often not available with direct giving or private foundations²⁰, ²¹.
• Successor Advisors: Donors can designate successor advisors to their donor advised fund, allowing their philanthropic legacy to continue across generations¹⁹.

The IRS provides guidance and regulations for donor advised funds, including rules on excise taxes and permissible transactions, which are important for both sponsoring organizations and donors to understand. New requirements for donor-advised funds were introduced under the Pension Protection Act of 2006, and further proposed regulations were issued in November 2023¹⁷, ¹⁸.

Limitations and Criticisms

While donor advised funds offer many benefits, they also face certain limitations and criticisms:

• Loss of Control: Once assets are contributed to a DAF, the donor irrevocably surrenders legal ownership. While advisory privileges are typically honored, the sponsoring organization has the final authority over grant distributions¹⁶.
• Lack of Mandatory Payouts: Unlike private foundations, DAFs are not legally required to distribute a minimum percentage of their assets annually. This has led to criticism that funds can remain dormant indefinitely, accumulating assets without promptly reaching operating charities¹³, ¹⁴, ¹⁵. This point is a subject of ongoing debate among policymakers and philanthropic watchdogs.
• Fees and Costs: Sponsoring organizations typically charge administrative and investment fees, which some critics argue can reduce the amount of money ultimately reaching charities. Donors have limited control over how their funds are invested once transferred, often being limited to a selection of preset investment options, such as mutual funds.
• Transparency Concerns: The ability to give anonymously through donor advised funds can reduce transparency in charitable giving, making it difficult for the public and even recipient charities to know the original source of large donations¹¹, ¹².
• Prohibited Benefits: Donors cannot receive any personal benefit (beyond the charitable deduction) from grants made through their DAF, nor can grants fulfill personal, legally binding pledges or benefit specifically designated individuals⁹, ¹⁰.

A comprehensive discussion of these issues, including potential regulatory proposals, can be found in academic and policy analyses, such as the Stanford Law School's examination of Donor-Advised Funds and their Critics⁸.

Donor Advised Funds vs. Private Foundation

Donor advised funds and private foundations are both charitable giving vehicles, but they differ significantly in structure, control, and administrative requirements.

The choice between a donor advised fund and a private foundation depends on a donor's philanthropic goals, desired level of control, administrative capacity, and tax considerations.

FAQs

Q1: What are the main tax benefits of using a donor advised fund?

A1: The primary tax benefits include an immediate tax deduction for contributions made to the DAF, and the avoidance of capital gains tax when donating appreciated assets like stocks or mutual funds⁶, ⁷. This allows the full value of the asset to be used for charitable purposes.

Q2: Can I choose which charities receive grants from my donor advised fund?

A2: Yes, as a donor, you have advisory privileges to recommend grants to qualified public charities from your donor advised fund. While the sponsoring organization has the final legal authority, donor recommendations are almost always honored⁵.

Q3: Are there any ongoing obligations once I establish a donor advised fund?

A3: Once you contribute to a donor advised fund, you surrender legal ownership of the assets. The sponsoring organization handles the ongoing administration, investment management, and compliance⁴. Your primary ongoing "obligation" is to recommend grants to charities over time, though there is no federal mandate for annual distributions, unlike with some other charitable vehicles³.

Q4: Can donor advised funds be used for international giving?

A4: Yes, many sponsoring organizations that administer donor advised funds facilitate international grantmaking to qualified charitable organizations abroad, subject to their specific due diligence processes and compliance with U.S. regulations².

Q5: How do donor advised funds grow?

A5: Funds contributed to a donor advised fund are typically invested by the sponsoring organization, often according to investment options recommended by the donor. The assets can grow tax-free over time, increasing the total amount available for future charitable grants and enabling greater impact for the charities supported¹. This growth is similar to how an endowment grows, generating more funds for distribution.