by Ryan McKeown, CPA, CFP®, Associate Financial Advisor,
Wealth Enhancement Group

A little known tax-planning tool that a lot of individuals may have not heard about is called a “Donor Advised Charitable Fund.”  Individuals can make irrevocable charitable contributions to one of these accounts, which is immediately tax deductible. Once the money is in the account, the earnings grow without income tax, and “grants” can be distributed when convenient to charities of your choice over time. The downside is that once the funds are in the account, they cannot be used for personal reasons anymore, only to be distributed to qualified charitable organizations.

There are several reasons why you should consider using these types of accounts. One reason would be if you are in a higher tax bracket now than you will be in the future. By making a contribution to a donor advised fund now, you will receive a higher level of tax savings than waiting until later. Another reason would be that you might not be itemizing your deductions in the future (you only receive a tax benefit for charitable contributions if you itemize). By making a contribution when you can itemize your deductions now, you would receive a tax benefit. If you make contributions later and you cannot itemize your deductions, you may not receive any tax benefit. With a Donor Advised Charitable Fund, you are able to put significant deductible contributions into the account now (accelerating your tax deductions) even though the funds may not be distributed for many years.

For example, John Doe contributes $10,000 to his Donor Advised Charitable Fund in 2009. John gets to deduct $10,000 on his taxes this year. Assuming a 25% tax bracket, John saves $2,500 immediately. Over time, John distributes his $10,000 and earnings (if any) to charities of his choice. If John passes away before all of the funds are distributed, those funds can be disbursed to charities or John can name a successor to the account to continue to distribute the remaining balance. Ultimately, all of the funds do need to be distributed to a qualified charitable organization.

Another strategy involving Donor Advised Charitable Funds is called “bunching” your charitable deductions. For example, John Doe usually gives $1,000 per year to various qualified charities. He is able to deduct $1,000 per year on his tax return by doing so. However, if John puts $10,000 into a Donor Advised Charitable Fund in the current year, he can deduct $10,000 immediately on this year’s tax return, then over the next ten years; distribute $1,000 per year to various qualified charities (his normal annual charitable giving). The $1,000 per year that is distributed is not deductible over the years because the initial $10,000 was already deducted. John’s charitable deductions are being “bunched” into one year and thus receiving a potentially larger upfront tax benefit by doing so.