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Market Update

Pros and Cons of Donor-Advised Funds

Donors benefit from an immediate tax deduction, tax-free growth, and investment flexibility.

President Joe Biden’s proposed tax-law changes have many investors wondering about how to adjust their portfolios to minimize the impact. In addition to potential increases in income tax rates and the maximum tax on capital gains, one proposal on the table involves limiting the step-up in basis for inherited assets. Under current tax law, the cost basis of inherited assets generally “steps up” upon the original owner’s death, meaning the beneficiary will only pay taxes on any gains over and above the stepped-up value. Biden has proposed limiting this benefit to $1 million per individual or $2 million per couple.

In addition, the 2018 tax-law changes make it more difficult to claim a charitable deduction. Because most investors now take the standard deduction instead of itemizing, it can be beneficial to “bunch” charitable donations by making a larger donation in a single year, which might push you past the threshold for itemized deductions, instead of making smaller annual donations that might not be tax-deductible. Donor-advised funds can facilitate this strategy because donors can make a bigger contribution to a donor-advised fund in a single year and take the itemized deduction up front, but still make charitable contributions over time.