Donor Advised Funds: Maximizing The Tax Benefit of Charitable Contributions

Do you make charitable contributions but find that you can’t deduct them for tax purposes because the standard deduction exceeds your itemized deductions?  If so, you can use something called a Donor Advised Fund (DAF) to group multiple years’ of future charitable deductions into one year for tax purposes and realize an immediate tax benefit.  This isn’t just shifting tax from one period to another as is the case for many tax strategies.  This will result in reduced taxes… more of your money kept in your pocket, or alternatively, more money you can give to those charities.

The Tax Cuts & Jobs Act (TCJA) imposed a limit of $10k per year that can be deducted as an itemized deduction for State & Local Taxes (SALT) paid each year.  Note that is true for both single and joint filers (i.e. the cap is not doubled to $20k for joint filers).  Additionally, TCJA doubled the standard deduction from $6k single & $12k joint to $12k single and $24k joint (inflation adjusted each year).  Finally, with depressed interest rates, many have been able to refinance their mortgage in recent years, leading to less of a mortgage interest deduction.  The combination of these factors has led to more and more filers taking the standard deduction rather than being able to itemize, meaning no additional tax benefit for charitable contributions.  With another wave of refinancing in 2020, even more taxpayers will find themselves in this situation. 

Let’s use some real numbers to demonstrate.  For 2020, the standard deduction is $12,400 for single and $24,800 for joint filers.  Let’s say that you’re married and your state income taxes and property taxes paid exceed the $10k limit, so you’d get $10k for SALT deductions in total due to the cap.  Let’s also say you have a $350k mortgage at 3% fixed, resulting in ~$10.5k of mortgage interest for 2020.  Finally, let’s say you give $4k per year to charity.  Since the SALT (10k) + mortgage interest (10.5k) + charitable contributions (4k) only total $24,500 of itemized deductions vs. the $24,800 standard deduction, it means that whether you made the charitable contributions or not, you’d still take the standard deduction.  You therefore get no tax benefit from the charitable contributions.  In fact, even if your total itemized deductions exceed $24,800, if the SALT + mortgage interest alone don’t exceed it, then some portion of your charitable contribution will provide no tax benefit.

If only there were a way to group several years’ worth of charitable contributions into a single year so you’d exceed the standard deduction (by a lot!), get a large tax benefit in that one year, and then take the standard deduction in the future years.  Enter the Donor Advised Fund.  A DAF is just an account with a DAF provider to which you make a lump sum contribution in a given year.  Since the contribution is irrevocable, and the DAF is a non-profit itself, you get to take the full amount of the contribution as a deduction in the year in which it’s made.  The money then remains in that account (it can even be invested) and you can make grants out of the account at any time to the charities of your choice.  Almost all charities, non-profits, and religious organizations are supported, though check with the DAF to make sure the organizations you want to support are allowed before making your contribution.

Back to the numerical example…  Instead of donating $4k each year for 5 years, you contribute $20k to a DAF in 2020 and then use the DAF to make $4k per year grants to the organizations you wish to support from 2020 – 2024.  In this case, your total deductions in 2020 amount to $40,500 (10k SALT + 10.5k mortgage + 20k charity) allowing you to itemize.  You’d then still take the standard deduction for the next four years.  The benefit is over $5500 of tax saved!

Even better, if you have highly appreciated assets, you can donate those and take a deduction for the fair market value of the asset, without ever having to pay capital gains tax on the asset’s appreciation.

Now, you may say that you don’t give to charity for the tax benefit, so who cares.  And it’s true.  No one gives to charity for the tax benefit because at most, you’d save $50 cents of tax for every $1 you donated which is clearly not a winning strategy.  But if each $1 you donate only costs you $0.50 cents with a tax benefit, then you could afford to donate twice as much with the tax benefit than without.  Therefore, whether you’re doing it to reduce your tax bill and keep more money in your pocket, or you’re doing it so you have more to donate to the charities (think of it as a government match facilitated by the tax code), there is a clear benefit to donate in a way that will allow you to take a tax deduction.

The typical DAF does charge an asset-based fee, but it is fairly low, in the 0.6-1.0% per year range.  The tax benefits of the DAF almost always outweigh any costs involved.  DAF providers typically cut off new account openings in early to mid-December in order to make sure they can get everything done by the end of year tax deadline, so if you’re interested in opening and funding a DAF, it is best to do so well in advance of end of year. 

In summary, DAF’s have low costs, allow you to reap substantial tax benefits, and still allow you to support the organizations that you typically support.  If your SALT deduction + mortgage interest deduction are below the standard deduction, and you make charitable contributions, you would almost certainly benefit from a DAF. 

Recent Executive Actions On Unemployment Benefits, Payroll Taxes, Student Loans, & Housing Assistance

On August 8, President Trump issued executive orders related to the extension of expanded unemployment benefits, the deferral of employee payroll taxes, an extension to the waiver of student loan payments and interest, and a directive to various cabinet members to take action to prevent residential evictions and foreclosures resulting from financial hardships caused by COVID-19. These orders were an attempt to circumvent the need for congressional action on additional COVID-19 assistance, which seems to have at least temporarily, resulted in a standoff in the Senate. The provisions in these orders are complicated and may result in legal challenges. There has been some additional guidance issued by the Dept. of Labor and FEMA, both of whom are involved in implementation. Below is a quick summary of what I understand so far related to these orders.

Unemployment – the CARES Act provided $600 per week of federally funded unemployment insurance benefits, in additional to standard state funded unemployment benefits. The additional $600 per week benefit expired on July 31, 2020.  This executive order and supplemental guidance authorizes states to voluntarily apply for aid from FEMA to fund an additional $300 per week benefit from August 1 through December 27, not to exceed $44 billion (which would only last about 5 weeks given the number of currently unemployed people). While the original order called for a $400 per week benefit, only 75% was to be Federally funded, with states picking up the additional 25%. Given fiscal issues at the state level, additional guidance was provided that states could treat their $100 per week as additional unemployment compensation or as a portion of their existing unemployment compensation paid (i.e. make the additional benefit $400 by taking the FEMA $300 and adding $100 to the current amount they pay OR make the benefit $300 by taking the FEMA $300 and treating $100 of the current unemployment benefit calculation as part of the program). Participation is up to the states and many seemed to be waiting for the supplemental guidance on their $100 per week portion before applying. To date, SD has announced it will not participate and AZ, CO, IA, LA, MO, NM, and UT have applied and been approved. It is unclear when payments will be able to begin for participating states due to administrative delays in changing unemployment systems to comply. Some states may begin in late August, with others starting payments in September. Some states, like SD, may choose not to participate at all. In order to receive the $300 or $400 supplement, individuals need to be collecting unemployment at a rate of at least $100 per week and must certify that they are unemployed or partially unemployed due to the disruptions caused by COVID-19.

Payroll Taxes – this order directs the Treasury Secretary to defer the collection of the employee portion of social security taxes (currently 6.2% of the first $137,700 of wages earned in 2020), for Sepember 1 – December 31 without interest or penalties. It also directs him to “explore avenues, including legislation, to eliminate the obligation to pay the taxes deferred” (i.e. forgive the taxes, rather than just defer them). This would apply for workers earning less than $4000 per bi-weekly period (adjusted equivalently for other payroll periods). Additional guidance is required from the Treasury Secretary as to how this program will work. In practice, employers collect Social Security taxes as the FICA portion of payroll taxes. If they fail to collect these taxes, they are generally responsible for paying them on behalf of the employee. That means that if an employer allows an employee to defer the tax to post-12/31 and the employee cannot pay, the employer could be on the hook for these taxes. From an employee perspective, deferral of the tax for a few months isn’t a big help if the bill then comes due in January for the whole deferral period. However, if the deferred taxes are forgiven, that would be a huge help. Payroll taxes can’t really be forgiven without Congressional action though, so forgiveness seems uncertain. Without additional guidance, it would be difficult for an employer to stop collecting the social security taxes. Even if they did participate and offer it to employees, it may cause financial stress in early 2021 for those employees that participate and need to pay the deferred taxes. Of course if there is any chance of forgiveness that is dependent on deferring the taxes to 2021, then employees have a strong incentive to participate as much as their employers allow them to. We’ll have to wait for further guidance to understand how (if) this order will ultimately work.

Student Loans – the CARES Act provided for deferral of student loan interest and payments through September 30, 2020. This order effectively extends that (voluntary) deferral period through December 31, 2020.

Housing Assistance – the CARES Act issued a moratorium on evictions that expired on July 24, 2020. This order does not extend that moratorium. Instead, it directs various cabinet member to take action to find ways to minimize residential evictions and foreclosures during the ongoing COVID-19 national emergency, to review existing authorities that can be used to prevent evictions, to identify funds that could be used to help renters and homeowners, and to consider whether any further halting of evictions are reasonably necessary to prevent further spread of the virus.

Congress has adjourned through Labor Day, so barring any emergency callbacks, which look to be a very low probability at this point, guidance on the programs above is all we’re likely to get from now till then. I suspect there will be another stimulus act passed in September/October, but these executive orders are likely to be it until then.