Washington, DC is abuzz with the Democrats’ race to pass a massive $3.5 trillion infrastructure package that they pledge will be fully paid for. As they look to fund wide-ranging programs that touch areas as diverse as child care, health care, education, and climate change, they plan to make a number of tax changes to fund those investments.
While the package is unlikely to significantly impact the taxes of those who earn less than $400,000, higher income individuals could see a number of substantial and far-reaching changes, including reversing provisions contained in the 2017 Tax Cuts and Jobs Act. Here are a few key examples of the potential changes:
- Individuals who earn more than $400,000 may see the top marginal income tax rate rise from 37% to the pre-2018 level of 39.6%.
- The Section 199A pass-through deduction, which allows certain pass-through business owners to deduct up to 20% of their qualified business income, may be repealed or may become unavailable to taxpayers who earn more than $400,000.
- The $10,000 cap on state and local tax (SALT) deductions may be repealed and replaced with limitations on itemized deductions (i.e., phaseouts, a 28% cap on the value of itemized deductions, etc.)
- Capital gains and dividend tax rates may increase for certain higher-income taxpayers from the current 23.8% (a 20% tax rate plus the 3.8% tax on net investment income) to 43.4% (the expected higher ordinary income rate of 39.6% plus the 3.8% tax on net investment income). It is worth noting that those higher rates are expected to apply to taxpayers with adjusted gross income in excess of $1 million, although that threshold could be as low as $400,000.
- The gift and estate tax rate may increase to 45% or higher with lower exemption amounts proposed ($5.3 million per person, $10.6 million for married couples), adjusted for inflation.
While we do not yet know the full scope of the changes, it’s clear that many of the planning techniques presently used by taxpayers may be curtailed or eliminated entirely. That’s why now is a critical time for planned giving professionals to educate high-net worth donors on the steps they can take to see significant tax savings by taking advantage of existing tax provisions and rates.
Here are six places to start:
1. Take advantage of the 100% charitable deduction for cash gifts in 2021.
Congress last year passed the CARES Act, which temporarily increased the adjusted gross income (AGI) limit for cash contributions to 100% for qualifying public charities for individual donors. That change expires at the end of the year at which point it will revert back to 60%. The increase in gift deductions may be used to make new gifts or to prepay existing multiyear pledges.
It’s important to note that these charitable giving incentives only apply to cash donations made to public charities. Non-cash gifts such as stock, real estate, or personal property and gifts to donor-advised funds or private foundations will not benefit from these provisions.
Why now? Donors have a limited window in which they can deduct 100% of cash contributions to qualifying public charities, rather than 60%.
2. Make gifts of appreciated securities
With capital gains tax rates expected to rise, it is an ideal time to take advantage of the current rates by giving appreciated securities such as publicly traded stock or mutual funds that have been owned for more than a year.
Why now? The chart below demonstrates the potential tax savings on a stock gift of $10,000 with current tax rates.
3. Leverage charitable gift annuities
Charitable gift annuities are a gift vehicle in which a donor transfers cash or property to a charity in exchange for a partial tax deduction and a lifetime stream of annual income from the charity. It can either be funded with cash (which would allow the donor to deduct 100% of AGI this year) or appreciated stock. There are two requirements worth noting when it comes to establishing a charitable gift annuity: the donor needs to be at least 60 years old, and she needs to contribute at least $10,000.
Why now? This is the final year that the AGI limit for cash contributions is 100%.
4. Use charitable remainder unitrusts
A charitable remainder unitrust enables a donor to make a gift to a trust and receive variable income for life, with the remainder of the income going to the nonprofit(s). That can be appealing to those with significantly long-term appreciated assets, including non-income-producing properties because a CRUT allows a donor to contribute that property to the trust and when the trust sells it is exempt from tax. By donating the assets in-kind to the CRUT, the donor will preserve the full fair market value of the assets rather than reduce it by large capital gains taxes. That generates more income for the donor and the charitable beneficiaries.
Why now? A donor can receive a variable lifetime income that includes a portion that is tax free. He receives an immediate tax deduction, bypasses or minimizes capital gains tax, as well as minimizes his estate taxes.
5. Bunch charitable gifts
The Tax Cuts and Jobs Act increased the standard deduction, which has driven many donors to “bunch” their charitable giving in predetermined years to ensure that their total deductions exceed the standard deduction. That means deferring gifts in years when she plans to rely on the standard deduction.
One way to bunch gifts is via a donor-advised fund, which is a charitable giving account that enables a donor to establish an account, receive an immediate tax deduction, then determine how the funds are invested. The donor then recommends distributions to charities.
Why now? Bunching charitable giving this year enables the donor to maximize the benefits of his charitable giving by consolidating tax-deductible charitable contributions that would normally be made over multiple years into a single tax year.
6. Establish a charitable lead annuity trust
A charitable lead annuity trust (CLAT) is a type of trust in which a charity, donor-advised fund, or foundation of the donor’s choosing receives annual payments—either for a set term or the donor’s lifetime. After the trust term ends, the remaining trust property passes to the donor’s beneficiaries, such as family members. It can be structured to enable the donor to be taxed on trust income, which enables the donor to receive an upfront income tax charitable deduction for the gift of the annuity interest. The lower the IRS interest rate, the more effective this technique is.
Why now? CLATs are most effective in a low-interest-rate environment, which is why the conditions for taking advantage of a CLT currently are favorable.
While there is little certainty about how the tax policies will change in the coming years, it is likely that the environment will be less favorable to high net worth individuals. That’s why it is an ideal time to educate donors so they can take advantage of the current moment.
If you need help developing planned giving strategies for your high net worth donors, reach out to Mike Degenhart at email@example.com.