Itemized deductions are dead. That was the truth for many taxpayers in 2018. The number taxpayers itemizing in 2018 dropped by 88% compared to 2017. A knowledgeable taxpayer will realize, if they are not itemizing on their return, then they are also not receiving any tax benefit for their charitable contributions. But, don’t be too quick to write-off your tax deduction for your philanthropy goals. The answer is donor-advised funds, and it’s not a new trick, it’s been around since about the 1930s.
What is a donor-advised fund?
In its simplest form, donor-advised funds front-load your charitable contributions and with proper tax planning, your itemized deductions will exceed the standard deduction.
Donor-advised funds are investment vehicles administered by a public charity. This might seem like a far off, complex, only rich person investment, but it’s actually not. Many brokerage companies offer donor advised funds. For example, Fidelity, Charles Schwab and Vanguard all offer donor-advised funds. And as a matter of fact, Fidelity Charitable was the largest charitable contributor in 2018, granting $5.2 billion to charities of the donor’s choice. This makes setting up a donor-advised fund as easy as setting up a broker account, something we are all familiar with.
How does it work?
When you create and fund an account with a public charity, you are making a tax-deductible donation to that charity. Initially, all the funds are invested based on your preferences. Then, at your discretion, you direct the funds to the charity(ies) of your choice. Your charitable contributions can span over many years until your donor advised fund is exhausted.
What is the tax savings?
Front loading your charitable contributions to a public charity allows you to boost your itemized deductions in the year of funding. Assume the following facts, you are married filing joint and plan to make charitable contributions of $8,000 each year for the next 5 years, you also have $10,000 in property tax and $5,000 in mortgage interest to deduct each year. Your total itemized deduction will be $23,000, but you will be taking the standard deduction and not receiving any tax benefit for your charitable giving for the next 5 years.
Now, keeping all else the same, instead, you decide to open a donor-advised fund and fund your account for the next five years with a $40,000 contribution. Your itemized deductions are now $55,000, far exceeding the standard deduction, you are now able to realize a tax deduction for your charitable contributions. Your tax savings would be $9,792 at a 32% rate. (($55,000 – $24,400) *32).
To take further advantage of your donor-advised fund, leverage your donation in a high-income year, considered your maximum donation and your adjusted gross income limitation.
Is a donor-advised fund right for you?
The facts of each taxpayer and their unique circumstances must be scrutinized to make any decisions regarding a donor-advised fund. Consult with your trusted advisor. Consider the following questions: what are your cash needs in the coming years? Do you have a pattern of charitable contributions and will this continue? What is your expected income for the upcoming years?