Maximize Donations and Minimize Taxes through Donor-Advised Funds

This article explains a great way to maximize donations and minimize taxes through Donor-Advised funds. 

Although there are many ways to donate such as helping to build a house, packing meals for the homeless and volunteering your time, this article is focused on the monetary aspect of giving.

The Benefits of Giving

For those that are fortunate and have the means to give, there are many benefits.  Not only for the charities that receive your donations, but also for you.

According to Dr. Laurie Santos, Yale Professor and host of the Happiness Lab podcast, the psychological aspect of giving can increase your happiness.  This does not matter whether the deeds are big or small.

In addition to increasing happiness this way, I also get a boast of joy during tax season.  This is because I am able to write-off the donation amount lowering my overall tax bill.

The Highs and Lows of Selling Stocks

One of my primary ways to fund donations is selling stocks.  I have various types such as stock options, Restricted Stock Units (RSU) and Employee Stock Purchase Program (ESPP) amassed over many years.  

Over time, these stocks have increased as much as 5-10 times, which is definitely a high.  For tips on investing and finding the next 10-bagger, see How to Invest: Stock Market Strategies.

The lows of selling a stock is when tax time rolls around.  This is a painful experience especially if you do not put money aside to pay for the tax bill.

If you are able to hold your stock for 1 year or longer, then you get the benefits of long-term capital gains.  Instead of paying your normal tax rate which can be up to 37%, long-term capital gains max out at 20%.  

In addition to federal taxes, be sure to also factor in your state taxes as some have up to 10-11% tax rate alone.

Federal and State Tax Example

The following example highlights the tax implication for a $10,000 stock gain.  The scenario compares both the short-term (held less than 1 year) and long-term impact (held more than 1 year).

Your $10,000 gain may shrink to $5,000 profit if you hold less than 1 year (short-term gain).  If you wait 1 year or longer to qualify for long-term capital gain, then your profits come closer to $6,500.  

You are able to write-off the amount you donate such as $5,000 or $6,500 in this example.  Check out SmartAsset capital gains tax calculator to determine your federal and state tax implications. 

So you may be thinking, wouldn’t it be great if I could donate the entire gain amount ($10,000) without needing to accommodate for taxes?  Yes, you can!  This can be accomplished through the Donor-Advised Fund.

The Donor-Advised Fund Explained

The Donor-Advised Fund allows you to donate cash, stocks and non-publicly traded assets.  

These donations are converted to an investment account that grows over time. You are able to use the funds to support nearly any qualified charity.

Lastly, you are eligible to take a tax deduction for the full amount of your donation.  Instead of the $5,000 or $6,500 amount in the previous example, you would be able to write-off the full amount ($10,000).

My Donor-Advised Fund in Action

I came upon the dream scenario of a 10-bagger recently.  I invested $3,000 in Tesla and in a year, it jumped 11 times to $33,000.

I debated whether to spoil myself and purchase a real Tesla with the profits.  Due to the pandemic and not really driving anymore, I felt altruistic and compelled to donate this money instead.

By donating the Tesla stock to my Donor-Advised Fund, I was able to prevent a future tax bill of nearly $10,000 for federal and state taxes. 

This is a win-win as I have the full $33,000 to grant to charities in the future and the joy of the full tax deduction.  

Considerations for the Donor-Advised Fund

There are some aspects of the Donor-Advised Fund that you should consider before diving in.  Here are a few important ones:

• Only 501(c)(3) charitable organizations can receive grants from the fund.
• For stock donations, you must hold them for 1 year or longer.
• There are administration and investment fees for this fund.
• Donating funds to a charity is not automatic. There is an intermediate step to validate the purpose of donation and charity before it gets approved.
• Your family can not personally benefit from the fund.  As an example, you can not donate to a university and ask for these funds to pay for your kid’s tuition.  If you are looking for an investment account for this purpose, read Beginner’s Guide to 529 College Savings Plan 

Tips to use Donor-Advised Fund

I opened a Fidelity Donor-Advised Fund earlier this year.  I found this to be extremely easy to use and wish I had opened this account sooner.

Here are a few tips specific to the Fidelity Donor-Advised Fund:

• You can share a fund with multiple family members.  This may be useful if you or your family members only donate sporadically.
• Before opening an account, check to see if your charity is officially listed as a 501(c)(3) organization.  Guidestar.org is a good site to utilize for this purpose.
• If you have a volatile stock like Tesla, transfer the stock first to a Fidelity Stock account before donating it to the fund.  This cuts down the lag time transferring from an outside brokerage which may take days to process. I learned the hard way when my Tesla stock dropped a few thousand dollars during that lag time.
• Consider donating highly appreciated stock first into the fund to maximize your tax benefits.  Donating cash into the fund should be secondary as you will receive the same tax benefit as donating directly to a charity outside the fund.

Summary of Donor-Advised Funds

If you donate to a church or charity and own stocks that have appreciated, the Donor-Advised Fund is an ideal way to maximize your donations and minimize taxes.

There are considerations to the Donor-Advised Funds however it’s a truly win-win for your designated charity (they receive more money) and for you (ability for you to write-off full stock amount) when you donate appreciated stocks.

If you plan to make significant donations or need help on a holistic tax strategy, talk to a financial advisor or tax accountant for professional advice.

About DadMBA: Through his schooling (he does have a MBA) & more importantly being a Dad, he has provided practical advice to family & friends on finances & other life topics.  He loves helping others thus the creation of DadMBA.