Updated: Nov 14, 2020
Private foundations (PFs) are not the only tools by which philanthropic investors can preserve their legacy of charitable giving. Donor-advised funds (DAFs) are becoming a popular option for donors who desire a more flexible giving structure. Although private foundations allow for more family involvement in giving, DAFs have distinct advantages as well. Here is my summarized comparison of the two:
DAF: The donor pays a fee to a sponsoring organization such as Fidelity Charitable Giving Account or JP Morgan Donor Advised Funds to set up their fund. Once the donor contributes cash, stocks and other assets to the fund, they receive an immediate tax deduction whether or not they pay out grants in the same year. The sponsoring organization sets up the DAF and assigns the necessary staff to manage assets and the grant-making process.
PF: The donor hires an attorney to create an EIN, prepare Article of Incorporation and complete the necessary state and federal applications to form a tax-exempt entity. The donor can contribute cash, stocks and other assets to the foundation for a tax deduction.
DAF: The sponsoring organization essentially does all of the administrative work – they manage assets, hire staff to administer grants, take care of tax compliance, and provide expertise.
PF: The organization establishes a Board of Directors and can hire staff to manage assets, distribute grants and complete other organizational needs. The Board of Directors also hires a CPA to prepare annual tax returns and manage tax compliance.
DAF: Minimal tax compliance is involved and is handled by the sponsoring organization. We should, however, expect tax compliance updates in the near future as the IRS had DAFs on it's 2019-2020 Priority Guidance Plan.
PF: The foundation must file Form 990-PF and all necessary state returns. A PF is required to pay an annual 1.39% excise tax on net investment income. The foundation is also subject to self-dealing restrictions, mandatory distributions, and other stringent tax rules and regulations.
DAF: The donor is not required to follow a formal grant-making structure, distribute grants in a restricted amount of time or adhere to a grant distribution requirement. Although the donor advises the sponsoring organization on their preferred grant recipients, the sponsoring organization makes the final decision on which grantees are selected. In practice, most sponsoring organizations distribute grants to the donor's preferred recipient.
PF: The private foundation establishes a grant application process or pre-selects grantee organizations to receive charitable funds. Every year, the foundation must make qualifying distributions that are approximately 5% of the prior year's investment assets. The Board of Directors has ultimate authority over what grants are made.
All things considered, both DAFs and private foundations allow donors to establish a legacy by which they can instill the value of giving throughout family generations. Tax implications, philanthropic values, and compliance all must be considered when choosing the best giving vehicle. For more information about donor-advised funds or private foundations, contact The Little CPA.
This material has been prepared for informational purposes only, and is not intended to provide, and should not be relied on for, tax, legal or accounting advice. You should consult your own tax, legal and accounting advisers before engaging in any transaction.