Zakat, Taxes, and DAFs: Understanding the Philanthropic Complexities
During the 2020 presidential elections, taxes were a hot topic on every candidate's policy platform. I heard candidates reference lowering taxes, raising taxes, eliminating taxes altogether. The conversation around taxes was not unique to this election, but 2020 was the year that I started to pay more attention to taxes beyond the income taxes I pay. One particular moment that caught my interest was Senator Elizabeth Warren’s proposal to tax a person’s wealth.
In Islam, taxing wealth is not a foreign concept. One of the five tenets in Islam is called zakat. Zakat, often described as a tax, almsgiving, or charity, is a 2.5% tax on wealth that you have held in your possession for at least one year. Zakat excludes wealth that is used on a regular basis such as your house, car, or everyday jewelry.
Zakat is a beautiful concept that is not just a tax but also an act of worship, a social justice strategy, and an economic equalizer. It is the oldest concept of welfare and a social safety net for Muslims, where those with financial privilege are commanded to share their wealth with those in need.
In discussions of economic inequality and tax reform, we constantly hear that the rich don’t pay their fair share. I have heard people in lower income brackets say they pay more taxes than large companies like Amazon. I have seen my middle class friends upset because they are in a higher tax bracket than most billionaires. How is that possible? The rich stay rich because they exploit tax loopholes that the average American is simply unaware of—and that’s by design. Let’s talk about two of those loopholes.
The first tax loophole is salary and compensation. Billionaires’ compensation consists of salary, stock, equity, and a host of other benefits. The problem is that income tax is only paid on the salary. For example, a CEO of a company can have a salary of $250,000 and receive 100,000 shares in stock options. She pays a 37% income tax on $250,000. Meanwhile, let’s say the shares are valued at $100,000, and the CEO sells them a year later, when they are valued at $250,000. She would only have to pay a capital gains tax, which is “a levy on the profit from an investment that is incurred when the investment is sold,” according to Investopedia.com. In this example, the CEO would pay 25% on the $150,000 that the shares' value increased by. She paid a lower tax on a lower amount of capital than what she actually earned. It is these types of tax structures and laws that contribute to the economic inequality we are experiencing across the nation.
The second loophole is a dark chasm known as donor advised funds. The infamous DAFs are financial tools that I am still trying to comprehend and wrap my mind around. Earlier this year, I started my journey in taking stock (no pun intended!) of my financial situation. I was evaluating my income, my wealth, my giving, and so I started to learn about donor advised funds. The American Muslim Community Foundation (AMCF) defines a DAF as “a giving vehicle that provides you with immediate tax benefits and allows you to support your charities of choice through grant recommendations on your own timetable. You can invest your balance, name the fund after a loved one, and pass it on generation to generation.”
Now as I’m evaluating my own income and giving, an email comes to me asking if RISE accepts stock. Since RISE began in 2016, a generous supporter each year asks if we can accept stock. And I would always respond no, because we didn’t have the infrastructure in place. As we started to explore the possibility of opening a brokerage account, I kept running into DAFs. I learned to my astonishment that people who donate stock to a nonprofit do not have to pay any capital gains on the growth of the value of the stock, AND they can take a tax deduction for the donation! We accepted our first stock earlier this year. And I have to admit, I forgot to sell the stock right away. I was scared because now the stock had increased almost 20%. I didn’t want to pay capital gains on that. Luckily our financial advisor reminded us that we are a nonprofit and didn’t have to pay taxes! From this perspective as a nonprofit, DAFs seemed like a win-win.
At the same time, I also learned that the wealthy can put their assets into a DAF and defer their taxes while paying out only the required 5%. Criticism of DAFs comes from the fact that many rich people use them to grow their wealth by hoarding the remaining 95% in their funds. Ostensibly, tax laws and tax incentives were created so that the wealthy would have agency in their charitable giving and, hopefully, increase it. But is that really what’s happening? Are billionaires actually giving more? And in my own position of relative privilege, how can I leverage these laws and incentives to benefit my community?
I decided to look more into these questions and contacted my friend Muhi Khwaja at AMCF. He helped me understand the inner workings of a DAF and the benefits of utilizing this vehicle to distribute my zakat to my favorite nonprofits and give more. In full transparency, I worked for two corporations before I transitioned to the nonprofit sector. I earned stock and purchased stock through the employee stock purchase programs. I’ve held some stock for almost 20 years and others for 10 years. Both companies are doing well—so well that the capital gains would be significant.
Now here’s where zakat and taxes intersect for me. After calculating my zakat this past Ramadan, I opened up a DAF at AMCF with my husband, and we named it after our moms. I transferred stock equivalent to the amount of my zakat into my DAF. Then I chose my favorite causes, nonprofits that are zakat-eligible, to distribute my zakat to.
By the end of Ramadan, all my zakat was distributed. I also will claim the tax deduction on my 2021 taxes this year. And I paid out all the funds in my DAF—not just 5%. When I calculate my zakat, right before Ramadan to double the blessings of charitable giving like many other Muslims, I dream of giving hundreds of thousands of dollars to charity. I dream of donating the entirety of a nonprofit’s Ramadan goal just by writing a check.
I’m not a billionaire, I’m not Melinda Gates or Mackenzie Scott, but I’m a philanthropist nonetheless. And by learning about the benefits of DAFs, I am making a conscientious decision to avoid capital gains taxes while I give more to nonprofits that are challenging gendered Islamophobia, masjids that have women on their boards, and organizations that are making the world a better place.
Senator Warren didn’t win the election, and unfortunately her proposal to tax wealth hasn’t come to see the light of day. While we learn about these tax loopholes and leverage them in funding the nonprofit sector, we need to reconsider systemic tax reform that provides for a more equitable structure. I believe that we can make progress toward a society that funds social impact work equitably, with organizations not just relying on generous individuals but also receiving their share of the wealth that they deserve.
As the founder of Reviving the Islamic Sisterhood for Empowerment, Nausheena Hussain is a social justice activist here to amplify the voice and power of her Muslim sisters. Nausheena is dedicated in building a movement to address leadership development, increase community engagement, and create a philanthropic legacy for change. Nausheena is a 2016 Bush Foundation Leadership Fellow and a fellow graduate from the American Muslim Civic Leadership Institute and Studio/E entrepreneurial program. She was named the 2012 Catalytic Leader by the Minnesota Council of Nonprofits and a 2016 Changemaker by the Minnesota Women’s Press. Married, with two children, she lives in Brooklyn Park, Minnesota.