Donor Advised Funds versus Private Foundations

Both donor-advised funds and private foundations allow individuals to support their favorite nonprofits; however, they each have their own unique rules to follow.

Donor Advised Funds

A donor-advised fund is a separate fund maintained by a 501(c)(3) organization called a sponsoring organization.  Many times these sponsoring organizations are community foundations or nonprofit arm of a financial investment firm.  An individual creates a donor-advised fund by making a contribution of normally cash or stocks to the fund.  Once the contribution is made, the sponsoring organization takes control of the funds (the donor cannot get the funds back); however, the donor advises the sponsoring organization to whom the distributions of the funds should be made.  Distributions from the fund should be made to qualified public charities.  With a donor-advised fund, the donor can receive a tax deduction for their charitable contribution when they make the donation to the donor-advised fund. Then the investments in the donor-advised fund can grow tax-free and the donor can recommend grants to specific nonprofits in future periods.  There is no government regulation requiring that funds from a donor-advised fund be donated to a nonprofit within a specific time period but many sponsoring organizations have their own policies.

Private Foundations

A private foundation is a separate legal entity and can be funded with cash and stocks similar to a donor-advised fund.  Both private foundations and donor-advised funds can also accept gifts of property and other tangible assets; however, some gifts of property to donor-advised funds may be limited by the financial investment firm.  With a private foundation, the foundation’s board (which can include the donor) is in full control of the funds and distributions, unlike the sponsoring organization of a donor-advised fund.  Distributions from a private foundation can also be made to a wider variety of beneficiaries while donor-advised funds are normally limited to 501(c)(3) public charities.  Although a private foundation may have additional benefits over a donor-advised fund, it is also subject to more stringent laws and rules.  Private foundations must file an annual Form 990-PF with the IRS, are subject to the excise tax on net investment income, and an annual 5% minimum distribution requirement.

Donor-advised funds have been a key area of interest to the IRS in recent years due to improper handling of funds.  Funds have been used for the personal benefit of the donor and have also been granted to nonqualified charitable organizations.  The IRS has since acted several provisions to improve the accountability of donor-advised funds and appears to be a continued focus of theirs which is something to keep in mind when determining which vehicle is a better fit for your needs.

Posted by: Carrie Minnich, CPA