Question: I’m exploring the possibility of setting up a private foundation, but the local community foundation is trying to sell me on something called a “donor-advised fund.” What is that and how does it differ from a private foundation? Answer: A donor-advised fund is a separate account that a public charity, such as a community foundation, establishes to receive contributions from a single donor or set of related donors. The charity has final authority over how the account is invested and distributed, but the donor or other individuals selected by the donor may recommend grants and provide advice on investments.
Answer: Donor-advised funds may be used to support any bona fide charitable purpose. By definition, they are not designated for the use of any single charity, specific charitable project, or specific field of interest. Donors do sometimes create a fund that is designated to benefit a named charity, like the local symphony, or support a specific charitable project, like renovation of a public park, or pursue a field of interest, like cancer research, but these are not donor-advised funds.
A variety of organizations now offer donors the opportunity to establish donor-advised funds. Community foundations have the longest history with these funds, but donors now have the option of tapping into gift funds that have been formed by large financial services companies such as Fidelity and Vanguard. Many universities and a growing number of charities operating in other fields also offer this giving vehicle.
Occasionally, a donor-advised fund is established as a separate trust, but more often it is simply a separate account held as an asset of the charity that establishes it. The public charity that creates the donor-advised fund typically executes a written agreement with the donor providing for separate accounting for the fund and reciting the other rights and restrictions associated with the fund. As with endowing a private foundation, the donor has made a completed charitable contribution as soon as assets are transferred to the donor-advised fund, and may deduct the contribution accordingly. Unlike a private foundation, gifts to a donor-advised fund are deductible at up to 50 percent of the donor’s adjusted gross income (gifts to private foundations are generally deductible only up to 30 percent of AGI, which is bad news for the Bill Gateses of the world).
As with a private foundation, any earnings of the fund are tax-free because they belong to the public charity. The earnings become part of the fund, and the donor has the opportunity to give advice with respect to the earnings, just as he or she would with respect to the initial contribution. The public charity may give the account a distinct name, which can include the donor’s name if that is the donor’s preference. For example, Mr. and Mrs. Q might establish the “Q Family Fund” at their local community foundation. Grant recipients will know that they are receiving assistance from the Q Family Fund, and they will acknowledge the gift accordingly.
Question: What are the advantages and disadvantages of a donor-advised fund as compared to a private foundation?
Answer: A donor-advised fund offers donors a way to remain deeply involved in determining how to distribute their wealth to operating charities without the annual tax on investment income, minimum annual payout, limits on business holdings, and other restrictions that apply to a private foundation. As previously mentioned, contributions to a donor-advised fund benefit from the more generous annual limitations on deductibility that apply to contributions to public charities. As with gifts to a private foundation, contributions of appreciated securities that are not publicly traded can be deducted at their full fair market value. Furthermore, the public charity that holds the donor-advised fund takes responsibility for all administration, including filing of all annual returns and preparing financial statements. The public charity typically charges an administrative fee for these services calibrated to the size of the fund. Professional staff at the public charity are available to help donors pursue their individual charitable interests and identify charities that can use grants in efficient and effective ways.
The principal disadvantage of setting up a donor-advised fund boils down to control. With a donor-advised fund, final authority for grants and investments is reposed in the board of the public charity that holds the fund, and the board technically has the power to override any recommendation the donor might offer. In practice, this rarely happens, but donors who care about retaining full control should think carefully before pursuing this option.
Catherine E. Livingston is a partner in the exempt organizations practice group of the law firm Caplin & Drysdale. For more information on the contents of this article or the services Caplin & Drysdale provides to private foundations, please contact Ms. Livingston at (202) 862-5089. The questions and answers presented here are illustrative only, and should not be considered tax or legal advice. If you need advice regarding the establishment or maintenance of a trust or private foundation, please consult with a qualified tax attorney or tax advisor.