Private foundations and DAFs: Short-lived synergy?
When families and their advisors contemplate establishing a charitable vehicle, they often compare and contrast the advantages of private foundations and donor-advised funds (DAFs). However, for many donors, the best choice isn’t either a private foundation or a DAF — it’s both. When used in combination, the advantages of a private foundation and a DAF can be synergistic, providing donors with a full spectrum of options for their philanthropic and wealth-management goals.
These options will change, however, if the recently announced Accelerating Charitable Efforts (ACE) Act becomes law. But for the time being, here are some of the benefits of using these two vehicles in tandem.
While a private foundation offers more control over grants and almost limitless flexibility for out-of-the-box giving, a donor-advised fund enables convenient, anonymous grantmaking. When donors have both vehicles, they have a complete toolkit for achieving their philanthropic goals.
Major gifts. Making a major gift to a favored charitable project or institution represents a significant commitment. To ensure that funds are used according to their wishes, which can include naming rights, donors may want to draw up a grant agreement — a legally binding document — to reflect those details. Because private foundations are independent legal entities, they can enter into such agreements, setting forth the purpose, terms, and conditions of their grant, with subsequent payments often tied to progress milestones. This option usually is not available for donor-advised funds because account holders are not agents of the sponsoring organization and cannot enter a legal contract on its behalf.
Balancing transparency and discretion. Private foundations cannot give anonymously because they are legally required to record their grants on their tax returns, which must be available for public inspection. In most instances, this transparency is an advantage: In addition to contributing vital financial resources to an organization or cause, foundations can attract public attention (which, in turn, can attract more resources), building awareness and support.
There are situations, however, when giving publicly does not serve the best interests of the donor. Sometimes funders prefer not to have their names associated with a grant, such as when the issue in question falls outside the usual scope of their foundation’s mission. (For example, a funder might want to support a local school even though the foundation’s mission is global.) To avoid confusing grantees, the philanthropist may elect to contribute from a DAF, which provides flexibility and discretion. And some philanthropists are concerned about having their business or professional reputation linked to a controversial or politically charged issue. Because the sponsoring organization is not required to show which grants are associated with each DAF account, a DAF is ideal for making gifts that require absolute anonymity.
Infinite giving options. Whereas gifts from a DAF are typically restricted to straightforward donations to U.S.-based 501(c)(3) public charities, a private foundation provides donors with many more giving options, including:
- Making grants directly to individuals and families facing financial hardship, emergencies, or medical distress
- Giving to foreign charitable organizations
- Making loans, loan guarantees, and equity investments in support of charitable purposes
- Providing funding to for-profit businesses that support the foundation’s charitable mission
- Setting up and running scholarship and award programs
- Running their own charitable programs
In addition, private foundations can reimburse members for reasonable and necessary expenses incurred in pursuit of their charitable purpose, including board meetings, administration, site visits, travel expenses, and even costs associated with starting the foundation.
Options for enabling discretionary grantmaking. Many philanthropists establish a charitable vehicle for the express purpose of uniting their family in shared, purpose-driven work. But what happens when members either can’t agree on an objective or want to fund their own areas of interest? In addition to granting as a group, some families give their members a portion of funds to donate as individuals. A private foundation can facilitate this practice of discretionary grantmaking. Alternatively, the family could set up a donor-advised fund that members could use to fund their side projects. Because neither the discretionary grants nor the grants made from the DAF would be subject to approval by the full foundation board, they each could serve as “pressure release valves” when individual interests threaten to derail mission and unity.
While private foundations can be funded with and hold a wide array of assets, DAFs provide a higher tax deduction for contributions as well as a higher total limit for combined annual contributions. Combining the two can return the best possible financial outcome for the donor.
Maximizing tax deductibility. The maximum that a donor can contribute to a foundation is 30 percent of one’s adjusted gross income (AGI). However, donors who have had a significant liquidity event may want to exceed that limit. Because contributions can be made both to a private foundation and to a public charity in a single year, additional cash contributions of up to 30 percent of AGI can be made directly to one or more public charities, including DAFs. By “stacking” contributions to a DAF and a private foundation, donors can effectively maximize their deduction. Note that the temporary suspension of the AGI cap on charitable deductions that applied in 2020 has been extended through 2021.
Funding with alternative assets. Private foundations can own nearly any type of asset, including partnerships, real estate, jewelry, closely held stock, stock options, art, insurance policies, and other valuables. A DAF may limit investment options to cash equivalents, publicly traded securities, and shares of mutual funds. Donations of real property and nonmarketable securities typically are sold or liquidated by the sponsoring organization.
A DAF offers fair-market value for a donation of long-term capital assets (e.g., real property, notes, and privately held stock), whereas a private foundation provides cost basis. However, because a private foundation can hold onto these assets and even put them to charitable use, there are other possibilities to consider.
Because no one can predict their future needs with certainty, establishing both a private foundation and a DAF provides maximum flexibility. Whereas DAF-sponsoring organizations’ policies typically ensure that family control over a DAF eventually sunsets, a private foundation is an independent legal entity, and control of its assets can be transferred from the founding generation to the next in perpetuity.
Finally, having both a private foundation and a donor-advised fund is ideal for donors to future-proof their philanthropy. Should a private foundation prove too cumbersome over the long haul, the assets can be transferred to a DAF. However, should a DAF prove too limiting, it’s all but impossible to do the reverse. Although DAF-sponsoring organizations are permitted to make grants to private foundations, most have internal policies prohibiting such distributions. By having both, should donors “outgrow” their DAFs’ philanthropic and investment options, they can turn to their private foundation. And should their initial forays into philanthropy, typically begun with DAFs, turn into either a “second act” for a retired donor or a family enterprise that includes the next generation, their foundations can serve as an enduring legacy.