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.