Benefits of Charitable Giving
In addition to giving back to the community, teaching a family good values, and feeling good about oneself, charitable giving has considerable tax benefits.
Charitable contributions can reduce the tax burden at the end of the year. A gift to a qualified charitable organization may entitle a person or a couple to a charitable contribution deduction against their income tax as long as they itemize deductions. A contribution to a qualified charity is deductible in the year in which it is paid.
If the gifts are deductible, the actual cost of the donation is reduced by the tax savings. For example, if a person or couple is in the 33% tax bracket, the actual cost of a $100 donation is only $67 ($100 less the $33 tax savings). As the income tax bracket increases, the real cost of the charitable gift decreases, making contributions more attractive for those in higher brackets. The higher the tax bracket, the larger the reward for giving.
While a person or couple can continue to donate to specific charitable organizations, we suggest that they consider creating a Donor-Advised Fund or a Private Foundation so they could create something that will continue long after their death.
Determining the Appropriate Charitable Giving Vehicle
Attached as Exhibit “A” is a chart that outlines the major differences between donor advised funds and private foundations. Both are good choices; it just depends on what is the best fit for the individual, or a family, and what works with their lifestyle.
- Donor-Advised Fund (“DAF”)
DAFs are the fastest-growing charitable giving vehicle in the United States because they are one of the easiest and most tax-advantageous ways to give to charity. When a person or couple donate to a DAF, they are making a donation to the organization sponsoring the fund that is immediately tax deductible. If the account is a DAF, a person or couple would advise the organization on how to grant the money out to their favorite charities. The donation is also invested based on preferences, so it has the potential to grow, tax-free, while the donor is deciding which charities to support.
2. Private Foundation
A private foundation is typically established by an individual or family member with a substantial initial gift. Private foundations are overseen by a board of directors or trustees responsible for receiving charitable contributions, managing and investing charitable assets, and making grants to other charitable organizations.
The primary advantage of a private foundation is the ability of the donor to maintain some level of control over it, such as its mission, how the assets are invested, and the affairs of the foundation. Individuals interested in becoming more immersed in the execution of their giving strategies including operating an organization, potentially hiring a staff and investment managers, actively managing grant making, and sponsoring charitable events are good candidates for a private foundation.
3. Comparison between DAFs and Private Foundations
At the most basic level, the difference between a DAF and a private foundation is control. A private foundation is a freestanding legal entity over which the donor retains complete control. A DAF is a giving account within a sponsoring charitable organization. The donor makes recommendation as to how those funds are invested and granted out, but the sponsoring organization must give its approval. If the donor wants complete control over the charitable vehicle, a private foundation is the way to proceed.
However, if the donor does not mind taking a slightly less active role, a DAF may be a better option. DAFs are typically promoted as the better wealth management solution because they offer higher tax deduction limitations. DAFs are administratively less complex to establish and operate than a private foundation. A DAF can be established immediately by the donor without the time and expense involved in establishing a private foundation. A DAF is not subject to the same legal and recordkeeping requirements imposed on private foundations, greatly reducing the ongoing administrative costs relative to private foundations. Further, while a private foundation must distribute to charity at least five percent of its assets each year, there is currently no legally required minimum annual distribution from a DAF.
Proceeding with a DAF
If a person or couple proceed with a DAF, there isn’t a lot of work on their part. They would create the DAF with an organization and make a tax-deductible contribution to the fund. The fund managers, which include some of the biggest investment companies, then carry out a dual mission of seeking positive returns on the assets, while making distributions to charities that they designate.
Proceeding with a Private Foundation
If a person or couple decide to move forward with a private foundation, there is significantly more work needing to be completed. However, it’s the tradeoff for having full control. The following are considerations for the successful management of a private foundation during the first year, and then annually thereafter:
- Task Checklist
- Determine the appropriate charitable giving vehicle: is a donor-advised fund or private foundation desired?
- Determine the intent for Foundation; prepare mission statement
- File articles of incorporation with Secretary of State
- Complete and execute organizational documents
- Apply for a Federal employer ID number
- Select board members; secure their agreement to serve
- Determine if any staff is needed; if so, hire staff
- Preparation for board meetings:
- Obtain minute book
- Determine bank and investment firm for foundation
Determine Accountant for foundation
- Have First Board Meeting
- Establish grantmaking policies and guidelines
- Determine expense and grants budget
Plan initial investments
- Plan initial grants
- Set up Operations
- Fund the foundation
- Establish record keeping system
- File appropriate documents with the IRS and NJ to formally set up the Foundation and secure tax exemptions
- Have Accountant prepare tax returns including Form 990 PF with IRS B. Articulating Intent for the Private Foundation
To facilitate faithful adherence by the board to the intent for the foundation, one has an obligation to carefully articulate the intent for the foundation and to provide clear guidance for present and future board members. The first step is to identify the mission. I suggest providing a clear and complete expression of the desired values, charitable philosophies, and objectives. A person or couple should consider describing specific types of charities or causes that they want their foundation to support. Consider whether certain geographic areas are to be favored. It is also a good idea to identify areas that are not to be supported by the foundation. I suggest creating clear long-term goals and objectives for the foundation.
- Selecting the Board of Trustees
Once the by-laws have been prepared, the by-laws will dictate how many members will serve on the Board for the foundation. Aside from selecting individuals who are inclined to follow the vision for the foundation, other factors to consider are a candidate’s background and interest in philanthropy, the individual’s area of expertise, such as investments, accounting, law, or charitable experience, a willingness to devote sufficient time to work the foundation, knowledge of the areas of charitable interests of the foundation, and a general desire to promote charity and the interests of the foundation.
Once the Board members have been selected, consider having a basic trustee handbook prepared for distribution to all trustees. This would include copies of all the important documents of the foundation, including the organizational documents, the foundation’s mission statement, its published guidelines, its separate internal guidelines, if any, its relevant historical information, including grant history, list of the trustees, their contact information, and their terms of office, list of committees, and committee members, list of staff, foundation policy statements on conflicts of interest, special grant policies, compensation and expense reimbursement policies, personal policies, and other relevant information.
2. Grantmaking Policies and Guidelines
If the desire is to have foundation play an active role in charitable giving, the establishment and publication of grant guidelines can be very effective. The preparation of formal guidelines, which are made available to the public and to any grantseeker that contacts the foundation, can prove to be very valuable. Guidelines typically are used to describe the values that the foundation wishes to promote and the types of organizations and causes that the foundation will support.
A foundation’s grant guidelines will typically include the foundation’s mission statement, a description of the types of causes and organizations that it will support, as well as those it won’t support, and a specification of the procedures that the foundation requires a grantseeker to follow in applying for funds, such as an application.
3. Organizations supporting Private Foundations
A hybrid approach that we have used with clients is the selection of a private foundation and the engagement of an organization, such as Foundation Source (in our local area), who undertakes a majority of the underlying entity work and guidance. You are still able to control and direct the organization, but a lot of the paperwork burden and administrative guidance is undertaken by the entity.
This Memorandum was designed to discuss both the Donor Advised Fund as well as a Private foundation, compare and contrast the two vehicles for charitable giving and explain some of their important features.
If you are interested in either vehicle, please give Kenneth C. Russell, our Pennsylvania Charitable Planning Attorney a call and we can guide you through your decision making and, eventually executing on your charitable intent.