Donor-Advised Fund or Private Foundation? 5 Key Considerations

By Clear Perspective Advisors on January 2, 2024

When you decide it’s time to move beyond making direct gifts toward a more strategic plan to fulfill your charitable giving goals, two of the most popular planned giving vehicles to consider include a donor-advised fund (DAF) or a private foundation. However, the first step to evaluating these options is recognizing that choosing a giving vehicle is not a binary decision. The best choice may be to start with one strategy and add the second one later. Or, circumstances may warrant implementing both at the same time.

Key # 1 | Grant requirements, flexibility and privacy

Do I have to pay out a certain amount each year?

Presently, the IRS does not require a minimum distribution from a DAF. Check with the sponsoring organization to determine if it requires one.

Private foundations, on the other hand, must meet an annual 5% minimum required distribution (MRD) based on the prior year’s net average assets. Therefore, it is essential that the foundation generates enough cash flow to cover the MRD, operational expenses and taxes (most private foundations are subject to an excise tax on net investment income).

Can I give anonymously?

Donors can remain anonymous when a grant is made from their DAF, but not when made from a private foundation because foundations must file a Form 990-PF, which lists the grant recipients and amounts received.

Who can receive funds?

DAFs cannot make grants to families or individuals, nor can they provide scholarships for an individual. Grants must be made to 501(c)(3) charitable organizations.

Private foundations are permitted to make grants to families or individuals that meet specific criteria set forth by the IRS. A foundation may also provide scholarships and choose the recipient.

Ask yourself:
Do you mind being in the public eye when it comes to revealing details about your charitable activities?

Key #2 | Start-up contributions, costs and tax deductions

What level of commitment is required?

Generally, donors can start DAFs with gifts as little as $5,000 to $25,000 and no legal fees. The recommended initial contribution to private foundations, on the other hand, is several million dollars, with significant legal fees typically incurred for formation documents (i.e., articles of incorporation and bylaws or a trust agreement) and the associated costs to apply for the foundation’s tax-exempt status with the IRS.

How much can donors deduct from their taxes?

Below is a chart of the maximum tax deduction limits as a percentage of the donor’s adjusted gross income. Contributions in excess of the annual limits can carry forward for up to five years.¹

How are contributions valued?

Gifts to DAFs are valued at fair market value. Contributions to private foundations are valued at fair market value for publicly traded securities and cost basis for nonfinancial or non- publicly traded assets (e.g., real estate).

Are there any taxes that must be paid?

A private foundation must pay an annual excise tax equal to 1.39% of its net investment income. DAFs are not subject to any excise taxes.²

Ask yourself:
Are you ready to pay professionals fees to establish your foundation and commit a significant amount of money for the foreseeable future to accomplish your charitable goals?

Key #3 | Control and convertibility

Can I hire family members?

A private foundation may hire qualified family members (and others), but their compensation must be reasonable. You cannot hire anyone through your DAF.

Can I create and run a program?

In addition to making grants to grantees, a foundation may directly run its own programs and philanthropic activities, called direct charitable activities (DCAs) that comply with IRS criteria. A DAF cannot engage in a DCA.

Ask yourself:
Are you willing to do the work required to run the foundation, such as serving on the board, participating in meetings, requesting and approving grant applications and filing all of the appropriate state and federal tax reports?

I am tired of running my foundation. Can I change from one structure to the other?

A private foundation can be converted to a DAF by granting all its assets to a DAF. DAF assets cannot be gifted to a private foundation.

Are there any reporting requirements?

Private foundations must file IRS Form 990-PF plus other state and federal filings. Donors do not have any reporting requirements for their DAF.

Key #4 | Investment choice

How are assets invested?

In a DAF, the donor must typically choose from a predetermined selection of investments offered by the sponsoring organization. When assets in a DAF exceed a certain size, the sponsoring organization may offer the ability to have them managed by the donor’s financial advisor in accordance with the organization’s investment policies. A foundation retains control over the investments, including the investment policy, the types of investments made and the investment manager(s).

Key #5 | Family legacy

How long can my family maintain control? Private foundations are under the family’s complete control, and their philanthropic legacy can continue in perpetuity. The power to advise the DAF regarding distributions generally reverts to the sponsoring organization after the original donors pass away, but can continue for one or two succeeding generations depending upon the sponsoring organization’s policies.

Ask yourself:
Are you committed to taking part in the complexities of controlling a foundation and following the rules applicable to them?

Strategies to Consider:

• For a DAF, consider front-loading your charitable contribution in a high-income year (e.g., coinciding with a liquidity event, business sale, large bonus, exercise of non-qualified stock options, etc.) when your contribution limits for a charitable deduction will be higher, and then distribute these funds to charities in the future when the timing suits your goals.
• Consider creating a DAF to work in conjunction with your private foundation to receive all or part of the required annual distribution, affording you more flexibility to time charitable support as you see fit.

The Bottom Line:

• DAFs offer a substantially lower barrier to entry, simplified record-keeping for tax reporting, privacy and the flexibility to initiate grant recommendations at the complete discretion of the donor.
• Private foundations offer complete control to a family in perpetuity but require an annual distribution and involve substantial additional work and ongoing legal and IRS compliance.
• Both charitable vehicles require careful consideration. Also, the decision doesn’t need to be either-or: It can be both.
• Lean on your financial advisor, who can help you weigh the pros and cons and work closely with you, your attorney and accountant to determine the optimal path forward to fulfill your charitable vision.

1. Source: IRS Publication 526, retrieved from https://www.irs.gov/forms-pubs/about-publication-526 on November 12, 2021.

2. Source: Internal Revenue Service, Tax on Net Investment Income, retrieved from https://www.irs.gov/charities-non-profits/private-foundations/tax-on-net-investment-income on November 12, 2021.