Smarter giving: DAFs versus private foundations

Smarter giving: DAFs versus private foundations

Nerre: Welcome back to Building More Than Business. I'm Nerre Shuriah, the National Director of Wealth Content and Knowledge. Today, we're talking about a topic that frequently comes up with business owners when they're considering philanthropy. What's the best vehicle to pursue it—a donor advised fund or a private foundation? And this is really important because as of the beginning of this year, a lot of the tax rules for donations from corporations or individuals have changed.

But before we get into that, I'd like to introduce you to my two guests here. My colleagues are Hank Dunbar and Jacob Clark. They're both experts in the philanthropic and charitable space, and I'm going to pause for a minute so they can introduce themselves. Hank, can you give us a quick introduction on what you do here at the bank?

Hank: Yes. I manage the philanthropic and charitable strategy team, Nerre, which is part of the wealth division of the bank. And we work with 501(c)(3) organizations and also with individuals who have a charitable intent. I have been in the nonprofit space since I graduated from college in 1981.

Nerre: Fantastic. Very impressive. Jacob, welcome. Can you tell us a bit about your title and what you do here?

Jacob: Sure. So I'm Jacob Clark and I am an institutional consultant here within our institutional asset management team at First Citizens. And so I get the honor and privilege to work alongside nonprofit clients, but also for-profit clients, as well as municipalities.

Nerre: Fantastic. Thank you. So there are a lot of different vehicles for a business owner to choose if they're looking to do something philanthropic. Can you give us a little overview, Hank, as to why giving is important for business owners?

Hank: Most business owners would tell you the primary motivator in making a charitable contribution is the tax implications, the benefits of giving from the tax perspective. But you don't have to dig much deeper than that when they tell you that it gives them a way to give back to the communities that they are doing business in. And it also gives their employees a sense of pride or accomplishment when they see that the business they're working for is giving back to the community that they live in, the community that they work in, to the organizations that benefit them in their day-to-day lives.

Nerre: I love that, especially from the employee perspective. But having that aspect in your employer, your career, where you're supporting the community and giving back, I think makes for a more well-rounded experience. Jacob, can you tell us of any experiences that you've had with companies giving?

Jacob: Yeah. So I think back to a local business owner that I was working with, and he was already supporting his local church in volunteering and serving, but he was ready to take another step financially. And so we had conversations around what would it look like for him to actually use his donor advised fund to help with funding some initiatives the church had going on. And we were able to do that with them and it was a really exciting moment for them as well as the church.

Nerre: Nice. One other aspect I think that it comes up with business owners is with family meetings. So we try to encourage families to communicate about their finances, communicate about the business and its future, but that can be really hard. It's hard to get them in the mode of relating to each other in a way other than maybe a sibling or parent-child relationship. And so we often use philanthropy as the basis of those family meetings. It's a nice way to start the conversation without sharing the entire personal financial statement with the next generation. Most parents aren't ready for all of that.

Hank: And I would add there, Nerre, that a lot of times when you're having those conversations at the table, if a family has a donor advised fund or if they have a private foundation, to allocate some of that contribution amount to a child or to children and let the children go out and determine who they want to give the money to. And then they come back and they make a case in front of their family and they say this is the organization we've chosen and this is why we've chosen it. A lot of times when parents see their children involved in that, they will actually up their giving. So if the child had $500 to give, the parents may give an additional $500. It's just a great family dynamic.

Nerre: What a wonderful way to pass on family values.

Nerre: So you mentioned the donor advised fund a little bit when you were talking. Can you expound on that and just sort of tell us what are the characteristics of a donor advised fund?

Hank: So a donor advised fund is an account sponsored by a charitable organization, a 501(c)(3) organization. Simple to set up, oftentimes online. They can require minimums of as low as $5,000. It's an immediate tax deduction. If cash is given, it's up to 60% of your adjusted gross income. If appreciated property is given, it's up to 30% of your adjusted gross income. Those are the best deductibility limits that you can operate with. If you give appreciated property, you get a deduction for the full fair market value of the assets on the date of transfer. It's flexible in terms of timing. You put the money in, the money can sit there, it can be invested, or you can put the money in and let it pass immediately out with just a required minimum for keeping the account maintained. Most people do a little bit of both. They'll put some in, they'll give some out, but they'll leave some in so that it can be invested. And those grants must always go to a qualified charity operating within the United States.

Nerre: That's a great overview of a DAF. So Jacob, I'll turn to you, remember we're comparing and contrasting today. Let's talk about the private foundation. Tell me a bit more about what does that look like?

Jacob: Yeah, absolutely. So when you think of a private foundation, they're a lot more complex actually. So a private foundation is its own legal entity, and so it requires not only that legal structure, but it's going to have a board of directors. It's going to have a lot more requirements, actually from the IRS even, to where they're required to give a 5% annual distribution to two charities based on the fair market value average from the year. And then when you even look at deductibility, you're looking at 30% cash and 20% of appreciated. But on the opposite side of that, within a private foundation, a lot of times folks like to use that for more of they want to continue a family legacy or have more family control within the private foundation, which is something that you may not do as much of within a DAF. As well as just you have a little bit more control when it comes to scholarships and international giving that you and the board of directors are overseeing manually rather than within a DAF, it's held at a charitable foundation elsewhere.

Nerre: So that private foundation almost becomes its own business. You can hire children, give them a job, which is great.

Hank: A private foundation in a business context can be a really good way to involve children who are not involved in the day-to-day operation of the business. They may feel like they're on the outside looking in, that they're not as engaged with that part of the family. So when you give them the task of operating the family philanthropy business, it brings them in closer to the fold and gives them a lot greater sense of participation in what's going on.

Nerre: Right. So you've both done a great job of giving me some more color around which is which. What's the donor advised fund, what's the private foundation? Let's get into a case study. I'm a business owner, I've got $5 million to give, which vehicle should I choose and what are the factors I'm considering when I make that selection?

Hank: $5 million to give? We're going to recommend strongly that you put it into a donor advised fund. That you invest it. That you set an annual grant-making goal to get money out, knowing that you have the flexibility to give nothing or less than or more than in any year, just so much flexibility. But we do encourage you to have a goal. It doesn't just need to sit there idly. It needs to be used. For a private foundation, if you have $10 million to put into a private foundation, that's a good thing. But Jacob and I will both tell you that we've seen donor advised funds into the tens and hundreds of millions of dollars.

Nerre: Wow. So I think the key here is use what's flexible for me as a business owner.

Hank: What works best for you.

Nerre: Right.

Hank: And you said, when you said business owner, people have historically thought of DAFs as being individual giving devices. They are just as an appropriate device for businesses as for individuals, and we encourage that with a lot of the business owners we work with.

Nerre: That's good to know. And also to point out that it doesn't have to be one or the other. You can start with a DAF, add in a private foundation, keep them both or get rid of one. It's very flexible.

Nerre: So let me turn to you, Jacob. You've got a lot of experience, boots on the ground with this. We talked about two really good giving vehicles. What are some misconceptions that you hear from clients when you raise these as possible solutions? And one that I hear frequently is, oh, a private foundation is only for the ultra-high net worth. I have to be super rich to set one up. Jacob, tell me what has been your experience with that misconception?

Jacob: Sure. So when we think of the private foundation, it is costly, and it does require definitely a certain level of upfront costs and continued cost. And so like Hank mentioned earlier, within the private foundation space, we recommend you come with about $10 million or so for the private foundation. Well, on the flip side of that, with a donor advised fund, it's not a costly startup. And with First Citizens, we actually, our minimum for the donor advised fund, the initial contribution is only $5,000. So it's very much attainable for not only business owners, but just families, for husband and wives, for individuals to contribute to their philanthropy moving forward.

Nerre: I love that low barrier to entry, and then you get all the benefits of the organization that you have with the donor advised fund.

Jacob: Absolutely.

Hank: The tax benefits of a private foundation and the tax benefits of giving to a donor advised fund are very different. The maximums on the private foundation side are lower. It doesn't mean that you can't give and generate a carryover for future years. It's just that you need to know about that going into it. You need to do some serious tax planning.

Jacob: Well, and that's not to say either that with a donor advised fund, you can only give $5,000. We mentioned earlier, I've seen clients who have had upwards of a hundred million and above in their donor advised fund. So it's very fluid for wherever stage of life that you're in.

Nerre: That flexibility is key. And so I think that's important. As I mentioned, there've been some tax changes this year. We'll include an article in the show notes for you if you want to get into a little more detail about what those changes are. So I'm still with you, Jacob. Let's talk a little bit more now about some other misconceptions or mistakes that clients make. And one that I see frequently is that once I fund the donor advised fund, I've got to give it all out. What do you say to that?

Jacob: Absolutely not. You can make your initial contribution, and you can give a little bit at a time or you can let it sit there for some time. I like to make sure clients are aware that within the First Citizens Donor Advised Fund, there is a small notable rule that you have to give at least one grant of $250 at least every 3 years. So that's the bare minimum, but we also see clients who they're active. They're giving on a monthly basis, whether that be to different organizations that they're supporting or the same organization. There's actually a way to schedule pay or grants within our program that you're like, hey, on the fifth of every month, I would like to give X, Y, Z grant to this organization that I dearly love and volunteer and serve with.

Nerre: Nice. So Hank, let me let you chime in. What are some misconceptions that you've seen with working with clients? Maybe you have an anecdote that you can share with us.

Hank: So, Nerre, one of the biggest mistakes people make, they're in such a hurry to sell a piece of real estate, or they're in such a hurry to sell appreciated stock, that they don't think about what that can do to impact their taxes. They just want to take advantage of what they perceive as an opportunity. So they sell it, they get a windfall, and they say, oh, I need to give some of this away. The time to do it is before you sell it because then you avoid the capital gains taxes on the appreciation. You get the full fair market value of the asset as a contribution. So we had a gentleman several years ago who owned an interest in a limited partnership. So he owned 10% of the limited partnership, and he knew that the limited partnership would be looking in the next 12 to 18 months to sell a piece of property, a very valuable piece of property.

So he knew that his 10% was going to be worth several million dollars, and he wanted to give something away. So he was able to give 1% of the limited partnership interest to fund a donor advised fund. Historically, a lot of DAF sponsors haven't had the sophistication to deal with complex gifts like the legal work required to transfer a 1% interest in a limited partnership and to value it. But now most DAF providers can handle gifts of complex assets. They can handle gifts of real estate. They can handle limited partnership interests. They can handle mineral rights. They can handle gifts of artwork, gifts of fine jewelry. And so it's just the maturity process of the DAF providers, the DAF sponsors, has progressed to where people can give just about anything.

Nerre: That's good to know that they've increased in their sophistication. I would say one place where I see it a lot is with what you mentioned, business owners looking to sell their business. They've already got a letter of intent and then they come to us for help or say they want to have charity share in it, and it's unfortunately a little too late at that point. Having that letter of intent is almost akin to a completed sale. So we do have an example of this type of transaction, whether you're giving cash or shares to a charity and what the impact of your taxes can be. If you check the show notes, you can see that one pager, which really lays it out for you with an example so you can understand the benefit of timing. Hank, do you have another example of where timing is really impactful before you make that charitable gift?

Hank: Again, the letter of intent is crucial, but something else to think about in light of a DAF or a private foundation or both is how what you're giving is structured. A nonprofit organization wants general operating dollars. Sometimes you can give too much to a nonprofit organization at one time and it kind of creates a windfall shock and they might not be able to handle it all at one time. So be very thoughtful in how you do that. You may want to contribute from your DAF to an endowment that has been established at an institution and make annual gifts to that endowment. That's fine. You just cannot use a DAF to satisfy an existing pledge.

Nerre: That's good to know. I would say with the timing, as you mentioned, if you know that you're going to liquidate whatever that asset is in the next say year to 2 years, it's a good time to gift it to a charity, but maybe not too long out because a charity can't hold shares for 5 years. It could negatively impact their tax-exempt structure or their taxes.

So this has all been really good information, really helpful. And I think the long and short of it is that you do need some thoughtful planning. You need a strategy around your giving, whether you're a business owner or just an individual. You really want to talk to an advisor to make sure you're considering the right vehicle, the timing, the tax impact and then some of the flexibility options that you want to retain. And lastly, the reward, right? Maybe volunteer some of your time with the organization, so that you get that personal reward from your giving.

Hank and Jacob, I really want to thank you for joining me today. This has been enlightening. You two are a wealth of information. I love to encourage people to get out there and support their communities. Thank you for sharing your expertise with us. We really appreciated having you. Hope you will join us again in the future episode.

Hank: Thank you, Nerre.

Jacob: Yes, thank you.

Nerre: And remember, you don't have to go it alone. We have First Citizens advisors that can help you with these decisions. Even if you're not necessarily ready yet to make the choice to donate or have the family meeting, raise it with your advisor, and we can help build the team around you to give you the resources that you need.

Thank you for joining us for this episode of Building More Than Business. We love having you, and if you know someone or a business owner that could benefit from this information, please share our link. You can find us on YouTube Music, Spotify or Apple, and we look forward to joining you again for the next episode.

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