When you’re working on the charitable components of a client’s estate or financial plan, one of the first areas you’ll likely explore is the structure. Certainly, you are familiar with both private foundations and DAFs as useful charitable giving tools. Before you jump into one or the other for a particular client, it’s important to review the similarities and differences between the two so that you can best achieve your client’s goals.
To help you evaluate a client’s options, here are three common myths about the differences between private foundations and DAFs.
Myth #1: DAFs are all the same and only private foundations can be customized
Private foundations will always differ from DAFs in important ways, not only because of their status as separate legal entities and the deductibility rules for gifts to these entities, but also because of the opportunities to customize governance. But it is a mistake to assume that a DAF is a cookie-cutter vehicle. The DAF vehicle itself is extremely flexible. Here’s why:
- DAFs are popular because they allow your client to make a tax-deductible transfer of cash or marketable securities that is immediately eligible for a charitable deduction.
- A DAF at the Foundation is frequently a more effective choice than a DAF offered through a financial institution. At a community foundation, your client is part of a community of giving and has opportunities to collaborate with other donors. The Foundation is itself local and is deeply knowledgeable about the needs of our region and the nonprofits meeting those needs.
- The Foundation can work with you and your client to build a charitable giving plan that extends for multiple future generations. That is because the team at the Foundation supports your clients in strategic grant making, family philanthropy, and opportunities to learn about local issues and nonprofits making a difference.
Myth #2: Deciding whether to establish a DAF or a private foundation mostly depends on size
The size of a DAF, like the size of a private foundation, is unlimited. The United States’ largest private foundations are valued well into the billions of dollars. Information about private foundations, ironically, is not so private. The Internal Revenue Service provides public access to private foundations’ Form 990 tax returns. That is not the case for individual DAFs.
Similarly, DAFs are not subject to an upper limit. Although information on the asset size of individual DAFs is not publicly available, anecdotal information indicates that some DAFs’ assets may total in the billions of dollars.
Indeed, a DAF of any size can be an effective alternative to a private foundation, thanks to fewer expenses to establish and maintain, maximum tax benefits (higher deductibility limitations and fair market valuation for contributing hard-to-value assets), no excise taxes, and confidentiality (including the ability to grant anonymously to nonprofits).
The net-net here is that the decision of whether to establish a DAF or a private foundation–or both–is much less a function of size than it is other factors that are tied more closely to the objectives a client is trying to achieve.
Myth #3: DAFs and private foundations are mutually exclusive
Make sure you’re aware of the benefits of using both a DAF and a private foundation to accomplish clients’ charitable goals. For example:
- DAFs can help meet the need for anonymity in certain grants, which is typically difficult using a private foundation on its own.
- A DAF can receive a client’s gifts of highly-appreciated, nonmarketable assets and benefit from favorable tax deduction rules not available for gifts to a private foundation.
- An integrated DAF and private foundation approach can help a client balance and diversify investment and distribution strategies to ensure that giving to important causes remains steady even in market downturns.
Some private foundations are even considering transferring their assets to a DAF at the Foundation to carry on their foundation’s mission. Terminating a private foundation and consolidating giving through a DAF is sometimes the best alternative for a client when the day-to-day management and administration of the private foundation has become more time-consuming than expected.
Along these lines, some families find that the tax rules related to investments, distributions, and “self-dealing” have become harder to navigate and are perhaps even preventing the family from maximizing tax benefits of charitable giving. Finally, the administrative load of managing a private foundation sometimes becomes overwhelming, especially when family members retire, pass away, or simply become busy with other projects.
The bottom line here is that we encourage you to reach out to our team anytime you are evaluating how to structure a charitable giving plan to achieve both your client’s charitable goals and financial goals. Our team is here to help.