New Laws and Charitable Giving
How do recent changes in the law affect your giving?
Read blow for the most current information:
Biden Administration Releases Details on Proposed Taxation of Split-Interest Trusts
On May 28, the Biden Administration released a general explanation of its revenue proposals for Fiscal Year 2022. The so-called “Green Book” provides more detail on these proposals than had been available previously. Of especial interest to gift planners, under the heading “Treat transfers of appreciated property by gift or on death as realization events,” pages 62-64 discuss the Administration’s proposed changes to the taxation of capital gain when assets are transferred during life and at death.
After describing that an owner who transfers an appreciated asset, either during life or at death, would realize a capital gain at the time of transfer, the explanation discusses exceptions to that general treatment, saying:
Certain exclusions would apply. Transfers by a decedent to a U.S. spouse or to charity would carry over the basis of the decedent. Capital gain would not be recognized until the surviving spouse disposes of the asset or dies, and appreciated property transferred to charity would not generate a taxable capital gain. The transfer of appreciated assets to a split-interest trust would generate a taxable capital gain, with an exclusion allowed for the charity’s share of the gain based on the charity’s share of the value transferred as determined for gift or estate tax purposes.
The implication for split-interest trusts, which we presume to include charitable remainder trusts (CRTs), pooled income funds (PIFs), and charitable lead trusts (CLTs), appears to be that capital gain allocable to the non-charitable portion would be taxed to the donor at the time of transfer. For example, if a CRT were funded with an asset in which the donor has a $100,000 capital gain and the CRT earned a charitable deduction equal to 60% of the funding amount, the donor would be taxable on $40,000 of the capital gain.
For years, the deferral or avoidance of capital gains tax has been a popular selling point for funding a CRT or PIF with appreciated assets. Applying an immediate tax to some of this gain would reduce this tax incentive and depress donor interest in CRTs or PIFs. The explanation raises some questions, however, whose answers could moderate the effect.
The donor would have a $1 million lifetime exclusion ($2 million per married couple) available to offset the reportable gain. The donor would also have a $250,000 exclusion ($500,000 per married couple) for all residences (not only principal residences). The exclusion under current law for capital gain on certain small business stock would also be available. Donors whose gain is within these exclusions should not be taxed under the new realization rules. Donors who will exceed these exclusions will also face the new capital gains tax with other types of transfers by gift or at death. The ability not to pay tax on the portion of the gain allocated to the charity and offset the remaining gain with a charitable deduction may be relatively appealing.
The excerpt quoted above includes the following:
- Capital gain in a transfer by a decedent to a U.S. spouse will not be recognized until the surviving spouse disposes of the asset or dies.
- Appreciated assets transferred to charity would not generate a taxable gain.
What does this mean for a CRT or PIF whose income beneficiaries are the donor and the donor’s spouse? Whatever doesn’t go to the donor or the donor’s spouse will go to charity, so arguably no gain should be taxable at the time of the gift in this case. From a tax policy standpoint, the charitable community could point out to Congress that the four-tier taxation that applies to CRTs already ensures that capital gain is taxed unless it goes to charity, so imposing a tax on some of this gain at the outset is unnecessary regardless of who the beneficiaries are. Likewise, for PIFs, income distributions from the trust are already taxable, and the trust almost always allocates capital gains to the charitable remainder.
For grantor lead trusts, the question is whether they will be governed by the timing rules set forth in the proposals for certain other grantor trusts, by the rules set forth for split-interest trusts, or by some combination of the two. For non-grantor lead trusts, as with CRTs and PIFs, the gain allocable to the non-charitable portion of the non-grantor lead trust would be taxable to the donor in the year the trust is created. Most non-grantor lead trusts are lead annuity trusts (CLATs) and many of those are designed to generate an income tax charitable deduction equal to or approaching 100% of the gift principal. In these cases, presumably there would be little or no capital gain for the donor to report when the CLAT is funded since the value of the non-charitable portion would be zero or close to it.
A gift annuity is a form of bargain sale. The percentage of capital gain that must be reported by the donor of a gift annuity already is determined under current law much as is proposed for split-interest trusts. One question is whether gift annuity donors might lose the current ability to spread this gain over the donor’s life expectancy when the donor is the primary annuitant. The proposals do not mention changing this treatment, but with such big changes to capital gain taxation being contemplated, it is worth keeping an eye out for.
How will retained life estates be treated? Will granting a remainder interest to charity with a life estate retained for the donor and/or the donor’s spouse be exempt, as it would seem it should? If not, will the gain exclusion for the charity’s share of the value or the $250,000/$500,000 exclusion for residences be available? The proposals are silent on these questions.
Lastly, the Administration proposes January 1, 2022, as the effective date for these changes. That leaves open a window for donors to make split-interest gifts in 2021 before the new rules, whatever their final form, would take effect.
There’s a lot to digest in the Administration’s revenue plan, and many modifications surely are in store before a final bill is reached. There’s also time for the charitable community to influence what those changes are. The treatment of capital gain in assets used to fund a split-interest trust would be a good place to start.
Proposed Changes to Capital Gains Tax Could Be a Big Boost to Giving
The American Families Plan proposed by the Biden Administration includes a long list of initiatives aimed at expanding government support of children and families. It would cover much of the cost of these initiatives through a series of tax changes that include a major overhaul in the tax treatment of capital gains. It is far from certain that these tax changes will become law, but it is worthwhile to examine how they might affect the behavior of your donors if they did.
Capital Gains Tax Today
Long-term capital gains, the appreciation of an asset that the owner has held for more than a year, is taxed at a top federal tax rate of 20% when the asset is sold by the owner. In 2021, the 20% rate applies to single filers with taxable income over $445,850 and married taxpayers filing jointly with taxable income over $501,600. The rate is 15% for most taxpayers below these thresholds.
When a donor gives long-term gain property to charity, the donor is allowed to deduct the current value of the property from taxable income and does not have to pay tax on the capital gain. This double tax savings provides a strong incentive for donors to give highly appreciated assets, such as stock, to their favorite charities rather than cash.
At death, appreciated assets passed to heirs through the deceased’s estate receive a “step-up” in basis. This means that the cost basis of these assets in the hands of the heirs is reset to match their value on the date of the deceased’s death. If the heirs were to sell the assets that day, they would owe no capital gains tax, no matter how little the deceased paid for the assets originally. In addition, the current federal estate tax exemption of $11.7 million per individual ($23.4 million per couple) eliminates the estate tax for 99.9% of estates. The combination of the step-up in basis and very high federal estate tax exemption means that for 99.9% of estates, the appreciation in assets passed through estates is never taxed. It also means that for all but 0.1% of estates, there is no federal tax incentive to give appreciated property to charity through the estate.
Proposed Capital Gains Taxes
The American Families Plan proposes a near-doubling of the tax rate on long-term capital gains from 20% to 39.6% for taxpayers with taxable income greater than $1 million. Believe it or not, there are over 500,000 U.S. taxpayers who make that much each year. For these donors, the tax benefits of giving long-term appreciated assets to charity will be greatly increased. Between income tax savings, and avoiding capital gains tax and the 3.8% Medicare surtax, they could save over $0.80 in taxes for every $1 of long-term appreciated assets they give to charity rather than sell themselves. The more highly appreciated the asset, the more they will save. Today, these same donors can save up to about $0.60 for every $1 of long-term appreciated assets they give to charity. Expect gifts of appreciated assets from these donors to increase substantially if this dramatic increase in their federal capital gains tax rate becomes law.
The American Families Plan proposes another change in the federal taxation of capital gains that would affect a far larger swath of donors than those with incomes greater than $1 million: elimination of the step-up in cost basis for inherited gains over $1 million ($2.5 million per couple when combined with existing real estate exemptions). As a result, instead of 0.1% of estates facing federal taxation, closer to 10% would. Estates would pay a 39.6% capital gains tax on gains passing to heirs that exceed the applicable exemption amount – 43.4% when you include the 3.8% Medicare surtax. If the estate were large enough to also owe federal estate tax, federal estate tax would also apply. Capital gains tax owed would be deductible from the estate taxableamount, so the total tax rate on the gains would be about 62%. Compare that to 40% today. Estate gifts of appreciated assets to charity would be exempt from federal taxation, creating a strong tax incentive for donors with more than $1 million of capital gain in their estate to transfer at least some of those appreciated assets to charity.
Proposed changes to how capital gains are taxed during life, and at death, would create strong tax incentives for wealthy donors to give long-term appreciated assets to charity throughout their lives and through their estates. Time will tell, however, whethera dramatic increase in the top federal capital gains tax rate or a repeal of the step-up in cost basis at death actually becomes law. The negotiation process in Congress over these and other tax proposals is likely to be lengthy and heated. The end result is anyone’s guess, but some sort of increase in the federal taxation of capital gains is a real possibility. Should that occur, charities should be able to attract more appreciated property gifts as a result.
$1.9 Trillion American Rescue Plan Will Affect Giving Only Indirectly
On March 11, 2021, President Biden signed the American Rescue Plan (ARP), a $1.9 trillion package of initiatives aimed at facilitating the U.S.’s recovery from the health and economic effects of the COVID-19 pandemic. The ARP provides economic assistance to individuals in a variety of ways, primarily to Americans making less than $75,000/year (or couples making less than $150,000/year). It also extends the Paycheck Protection Program for businesses, creates block grants to help schools reopen and expand childcare, provides aid to state and local government, and much more.
What the ARP does not contain is any provision directly related to charitable contributions. For example, it does not extend further the charitable deduction for non-itemizers or the 100% of AGI limit election available for gifts of cash to public charities, both of which are set to expire at the end of 2021. Rather, the ARP’s effect on gift planning will depend on how much it hastens an end to the pandemic and catalyzes an economic recovery. The sooner those two things happen, the more confident donors will feel about their future and the more readily they will make outright and planned gifts.
We expect that Congress and the Biden Administration will turn their attention to a tax bill sometime in the next several months that, if passed, will assuredly have important implications for fundraising. Keep your eyes open for tax talk in Washington. We will be.
Consolidated Appropriations Act of 2021 Gives Special Tax Incentives for Giving
Congress has provided several economic incentives to help address the far-reaching effects of the COVID-19 pandemic, including additional tax incentives to encourage charitable giving. We would like to bring to your attention temporary tax rules for charitable giving enacted by Congress late last year [signed December 27, 2020] as a part of the Consolidated Appropriations Act of 2021. Note that these incentives are temporary and are scheduled to expire at the end of 2021.
You may deduct gifts of cash to most public charities to offset as much as 100% of your income! For the 2021 tax year, you may deduct cash contributions to Fenway School of Psychology and most other public charities to offset up to 100% of your income. Ordinarily, the income tax charitable deduction for cash gifts is limited to 60% of your income. This 100% limit allows especially generous donors to reduce their federal income tax to zero. If you are even more generous, you can carry forward unused cash contribution deductions for up to five years.
It may not be the tax-wise choice to deduct up to 100% of your income. Because federal income tax rates are progressive, it is not a given that it will be to your advantage to deduct 100% of your cash contributions. Check with your financial or other advisors to determine whether the 100% deduction makes sense for your specific circumstances.
If you don’t itemize you may reduce your taxable income by $300 for your charitable contributions in 2021. If you do not itemize your deductions, you can still reduce your taxable income by up to $300 (or $600 for married couples filing jointly) for contributions of cash to public charities using an “above the line” adjustment to reduce your taxable income.
Qualified charitable distributions are still a great way to make contributions if you are 70½ or older. A qualified charitable distribution (“QCD” or “IRA charitable rollover”) allows you to make a tax-free gift of up to $100,000 to Fenway School of Psychology from your IRA if you are 70½ or older. A qualified charitable distribution is a great way to make tax advantageous contributions, especially if you don’t itemize your deductions. [The CARES Act suspension of the required minimum distribution from most retirement plans for 2020 does not appear to have been extended into 2021.]
You have important priorities for your family and loved ones, and we know that their health and financial well-being comes first. When you are ready, we will be here to help you shape a charitable gift plan that suits your needs and allows you to keep helping with our important work. Please contact Dr. Edwin Price at firstname.lastname@example.org or call (555) 555-5555 to learn about the many ways you can support Fenway School of Psychology.