October 25, 2022

Charitable Planning: Donor-Advised Fund or Private Foundation?

Atlanta high-net-worth individuals and families have many considerations for charitable giving strategies as part of their estate plan. In a sea of options, two of the more common choices include either a donor-advised fund (DAF) or a private foundation. Both will provide certain tax benefits and help individuals and families further their legacy. However, depending on the situation, one may be a better option than the other. There are several factors to consider when deciding which approach makes the most sense. To help clients, prospects, and others, Wilson Lewis has provided a summary of the key considerations below.

How Does a Donor-Advised Fund Work?

A donor-advised fund (DAF) is a charitable fund established through an existing public charity, or sponsoring organization. Funds inside a DAF can be invested tax-free, and donors can choose to put in cash, securities, cryptocurrency, business interests, and other assets. They are a popular charitable giving option because they: 

• Are flexible and accept many different types of assets
• Allow upfront tax deductions
• Permit a certain level of control over assets
• Require less funds than a private foundation
• Can be passed on to heirs through a bequest in a will or succession plan

Due to the upfront tax deduction, donors can choose the timing of the charitable contributions. Additionally, certain donations can go even further. DAFs established with cash, check, or wire transfer are eligible for a tax deduction worth up to 60 percent of adjusted gross income (AGI). Donations of long-term appreciated securities can be worth 30 percent of AGI.

DAFs cannot disburse funds to crowdsourcing, political campaigns, or private foundations.

When setting up a DAF, it’s a good idea for donors to choose a sponsoring organization that aligns with their beliefs and charitable purposes.

What Is a Private Foundation?

A private foundation is its own separate, legal entity. Families establish private foundations with their own funds; often, family members are directly involved in grantmaking, too. In this way, private foundations give donors full control over how assets are distributed for charitable purposes. Private family foundations comprise about half of all U.S. foundations, a mark of their popularity in charitable planning strategies. 

Establishing a private foundation is relatively the same as any other tax-exempt organization under Section 501(c)(3). Maintaining its status as a private foundation involves compliance with other requirements. These are restrictions and provisions surrounding:

• Self-dealing between other private foundations and substantial contributors
• Annual requirements to disburse income for charitable purposes
• Limits on private company holdings
• Investments are prohibited from conflicting with charitable purposes
• Expenses must be for the benefit of charitable purposes

Private foundations are also required to file Form 990-PF with the IRS each year, maintain a Board of Directors, and must pay tax on net investment income of $500 or more throughout the year.

Differences Between a DAF and a Private Foundation

Even though both a DAF and a private foundation can help families accomplish their charitable giving goals,  there are significant differences in how those goals are met.

Where a private foundation maintains full control over charitable giving, a DAF provides more limited control over how assets are used. While donors can specify certain purposes for DAFs and can assist in some grantmaking responsibilities, ultimately it is up to the sponsoring organization to administer and carry out the fund. The upside is that donors don’t need to worry about annual reporting, grantmaking, or other administrative or regulatory duties. 

A DAF essentially works on autopilot once it’s established.

On the other hand, establishing a private foundation with the intent of maintaining full control over how assets are used also means more intense, ongoing legal and regulatory compliance. Families will need to retain outside advisors, like lawyers and accountants. It tends to be more time-consuming and costly than a DAF. Often, families can lose sight of the extra costs and work involved in running a private foundation.

Other Considerations for High-Net-Worth Charitable Planning

These aren’t the only two charitable planning options for high-net-worth individuals and families. There are several other considerations, including:

• Partnering with an existing tax-exempt organization to start a scholarship fund
• Sponsoring a project with a charitable group organization
• Establishing a for-profit social enterprise, which is subject to fewer restrictions. Examples are a benefit corporation (B-corp), social purpose corporation, low-profit LLC, and benefit LLC.
• Pooled-income funds (PIFs), which are a type of split-interest trust

The first two options allow donors to work with an existing organization. There is already an operational structure, staff, and volunteers. Compliance will be taken care of for the most part. Negotiations between the donor and the organization can help to create a solution that meets both parties’ goals.

For-profit social enterprises are growing in popularity. These entities are allowed to sell a product or service, make a small profit, and still use most of their proceeds toward a charitable cause.

Finally, PIFs – which are irrevocable pooled assets from individuals, a family, or a charity – can be set up to disburse funds for two to four generations. There are several considerations with PIFs, as they tend to produce higher returns the longer they’re established. The rate of return is also dependent on the federal interest rate.

Which Option Is the Best Approach?

As with any charitable giving strategy, there’s no single right answer. Asking the right questions up front can help to guide donors toward a clearer path, though. Consider:

• Giving priorities: Can the current giving priorities sustain one or two generations? Are they broad enough to evolve over time or do they need to remain restrictive?
• Family involvement: How involved do the donor and his or her heirs want to be? Running a foundation can be a full-time job, whereas a DAF requires considerably less time and attention.
• Tax benefits: Both charitable planning strategies have tax benefits, but they differ in how those benefits are realized.
• Funding: A DAF can be established with far less money than a private foundation. It’s recommended to have at least $1 million in seed money to start the foundation versus $5,000 to $25,000 for DAFs.

Contact Us

There are several different reasons why one may select a DAR over a private foundation. A qualified tax advisor can help to identify the best options based on your needs. If you have questions about the information outlined above or need assistance with an estate tax issue, Wilson Lewis can help. For additional information call 770-476-1004 or click here to contact us. We look forward to speaking with you soon.