Private foundations and donor-advised funds (DAFs) are two types of philanthropic vehicles that offer tax benefits to donors. While both are ways to give to charitable causes, they have different structures and tax advantages. In this article, we will explore the tax benefits of both private foundations and DAFs and provide examples to illustrate how they work.

Private foundations are organizations established by an individual or group of individuals to promote charitable activities. These foundations are usually endowed with a significant amount of money and are managed by a board of trustees or directors. Private foundations are classified into two types: operating foundations and non-operating foundations.

Operating foundations carry out their own charitable activities and provide direct assistance to beneficiaries. Examples of operating foundations include hospitals, museums, and universities. On the other hand, non-operating foundations do not directly engage in charitable activities. Instead, they support other charities by making grants to qualified organizations.

Income Tax Deduction: Donors can deduct contributions made to private foundations from their income taxes. The amount of the deduction is limited to 30% of the donor's adjusted gross income (AGI) for gifts of cash, and 20% of AGI for gifts of appreciated property. However, excess contributions can be carried forward for up to five years.

Capital Gains Tax Avoidance: When donors contribute appreciated assets, such as stocks or real estate, to a private foundation, they can avoid paying capital gains taxes on the appreciation. The foundation can sell the asset and reinvest the proceeds without paying capital gains taxes.

Estate Tax Planning: Donors can use private foundations as a part of their estate plan to reduce estate taxes. By transferring assets to a private foundation during their lifetime, donors can reduce their taxable estate and potentially save on estate taxes.

John and Jane Appletree established the Appletree Family Foundation, a non-operating private foundation, with an endowment of $7 million. The foundation's purpose is to support educational and environmental causes. The foundation's board of trustees includes John, Mike, and two independent members.

The Smiths contribute $2 million to the foundation in the first year. They can deduct the full $2 million from their income taxes and potentially save on estate taxes. The foundation invests the funds and earns a return of 8%.

In the second year, the foundation makes grants of $200,000 to five qualified organizations that support the Smiths' causes. The foundation also pays $50,000 in administrative expenses, including salaries and overhead. The foundation's assets have grown to $2.08 million at the end of the year.

In the third year, the foundation receives additional contributions of $500,000 from John and Jane and $500,000 from other donors. The Smiths can deduct their contribution of $500,000 from their income taxes. The foundation invests the funds and earns a return of 6%.

In the fourth year, the foundation makes grants of $300,000 to seven qualified organizations. The foundation also pays $70,000 in administrative expenses. The foundation's assets have grown to $1.26 million at the end of the year.

By establishing the Smith Family Foundation, John and Jane can support causes they care about and receive tax benefits for their charitable giving. The foundation's assets have grown over time, allowing it to make larger grants to qualified organizations.

Donor advised funds (DAFs) are charitable accounts managed by public charities. Donors can make contributions to their DAF accounts and recommend grants to qualified charities. The sponsoring charity handles the administrative work and invests the funds until the donor recommends a grant. DAFs are a flexible and efficient way to support charitable causes.

Income Tax Deduction: Donors can deduct contributions made to DAFs from their income taxes in the year they are made. The deduction is limited to 60% of the donor's AGI for gifts of cash and 30% of AGI for gifts of appreciated property. However, excess contributions can be carried forward for up to five years.

Capital Gains Tax Avoidance: Donors can avoid paying capital gains taxes on appreciated assets by contributing them to a DAF. The fund can sell the assets and reinvest the proceeds without paying capital gains taxes.

Timing of Giving: Donors can contribute to their DAF accounts in one year and recommend grants to charities in future years. This allows donors to time their giving to maximize tax benefits

Suppose a donor contributes $70,000 of appreciated stock to a DAF. The stock has a cost basis of $20,000 and is worth $70,000 at the time of the donation. The donor can deduct the full $70,000 from their income taxes and avoid paying capital gains taxes on the $50,000 of appreciation.