Proposed Tax Reform and Philanthropy

Take-Away: With much of the tax reform being talked about in Congress this past spring and this summer, little has been said about the possible impact of some of the tax proposals on philanthropy. Some planning options may be curtailed, yet others will continue to exist, and may even present better tax-saving opportunities if income tax rates increase in future years.

Background: There are several tax reform bills pending before Congress, and President Biden has also announced tax reforms as part of his 2022 proposed fiscal budget. How some of those proposals would impact philanthropy follow:

Capital Gains at Death: Many individuals who hold appreciated assets intentionally hold onto those assets planning a step-up in the inherited asset’s income tax basis to its date-of-death value. That assures their heirs and descendants the ability to sell the inherited asset without incurring much (if any) capital gain. If President Biden’s proposed deemed disposition on death rule is enacted, the incentive to hold onto appreciated asset until death to obtain an income tax basis step-up of the asset disappears. Such a rule change might encourage those owners of appreciated assets to consider gifting those appreciated assets, especially marketable securities, to a charity, in order to obtain a large lifetime charitable income tax deduction that can be used to lower their taxable income, particularly if they expect federal income tax rates to increase in the coming years.

Note: If there is a carry-over in an inherited asset’s income tax basis, and those inherited assets have to be sold in order to help pay federal estate taxes, it is possible that the capital gain incurred on the sale by the decedent’s estate will then be available as a federal estate tax deduction which can be used to reduce exposure to potentially higher marginal estate taxes.

Capital Gains with Gifts: Along the same lines, President Biden has proposed a deemed disposition of assets when those assets are gifted during the donor’s lifetime. Even placing the appreciated asset in an irrevocable trust would be considered a realization event for the donor. There is no exception in the President’s budget proposal for transfers of appreciated assets to a charitable remainder trust (CRT) or other split-interest gifts to charities, e.g. charitable gift annuities (CGA’s) or charitable lead trusts (CLTs).

CRT’s: Under the President’s budget proposal, capital gains tax would be imposed on a proportional basis, with the capital gains tax due on the portion of the gains that are allocated to the donor’s percentage interest in the value of the assets used to fund the CRT. This creates a big problem for the donor- the donor would now owe capital gains taxes on the increased value of assets transferred to the CRT (or other charitable device) while having no access to the proceeds from the sale of the appreciated asset held inside the CRT. Under current law, those capital gains would be recognized and paid by the donor to the CRT over the donor’s lifetime distributions from the CRT.
CGA’s: This proposed rule change would be akin to the long-standing treatment of capital gains tax due on the gain inside assets that are used to fund a charitable gift annuity (CGA) when the donor is not a beneficiary of the CGA, when the donor must recognize the percentage of gains equal to the value of the lifetime payments divided by the total amount that is used to fund the CGA. If the donor is a beneficiary of a CGA that is funded with appreciated property, that too is a realization event. However, no tax is actually due at the time the annuity is funded. Rather, the tax on the portion of the realized gain that is allocated to the value of the donor’s income interest in the CGA is recognized on a prorated basis when the donor receives annuity payments over the donor’s life expectancy. Thus, the result is the avoidance of capital gains allocated to the charitable gift value and deferral of the capital gains tax on the remainder of the gains until received as a portion of the donor’s lifetime annuity payments.
CLT’s: Funding a charitable lead trust (CLT) could pose problems for donors if a capital gain is realized when the CLT is funded with appreciated assets, rather than providing for a carryover income tax basis in property that will eventually be received by the CLT’s non-charitable remainder beneficiaries. Again, the donor will be required to pay a capital gain tax when the donor will not have access to the assets received (or sold) by the CLT with which to pay the capital gain tax.
Observation: If the deemed disposition on transfer rule becomes law, hopefully the same approach for CRTs as with CGA’s could be used, where the portion of capital gains allocated to the value of the CRT income interest retained by the donor would be realized at the time the CRT was funded only for the benefit of someone other than the CRT’s settlor.

Charitable Planning Techniques that Would Not Change: Some of the existing charitable giving techniques that apparently would not be threatened with the proposed tax law changed are:

Gift of Appreciated Assets: The gift of appreciated securities or other assets held long-term are still tax deductible at their fair market value, no matter how low their cost basis. Such lifetime gifts are deductible up to 30% of the donor’s adjusted gross income (AGI), with any unused portion of the charitable deduction carried forward for up to 5 subsequent tax years. These lifetime gifts of appreciated assets may become more important if there is a deemed disposition at the owner’s death, where the inherent capital gain would become [along with their IRA] income in respect of a decedent [IRD].
Charitable Step-Up Strategy: If there is to be a deemed disposition on the owner’s death of his or her appreciated assets, the donor might consider gifting the appreciated securities to charities now, and using the cash that would otherwise have been donated to charity on death to repurchase the securities. Those steps would result in a higher income tax cost basis for the securities for capital gains recognition purposes on the owner’s death.
Charitable Gifts of Cash: Lost sight in all of the legislative initiatives that are attracting so much publicity is the fact that for 2021 only, immediate gifts of cash to charities qualify as charitable income tax deductions up to 100% of the donor’s AGI. Excluded from this cash-opportunity are cash gifts to private foundations, donor-advised funds, and CRTs. This gifting opportunity is best for those individuals who hold a lot of cash, who have a relatively low AGI for 2021, and who hold significant other assets. Thus, a large cash gift to a charity in 2021, up to the donor’s AGI, could completely eliminate any federal income tax liability for the donor for 2021.
Qualified Charitable Distributions: The opportunity of those individuals 70 ½ or older to give up to $100,000 from their traditional IRA as a qualified charitable distribution (QCD) still exists. Not receiving taxable income as a required minimum distribution (RMD) is the same thing as receiving the income and then gifting the income to charity. Restated, the QCD is the equivalent to an above-the-line charitable income tax deduction that is not reported as part of the donor’s AGI. Using a QCD also keeps the donor’s AGI lower which can impact the donor’s ability to claim other tax deductions that are tied to the donor’s AGI.
Split-Interest Charitable Gifts: Split-interest gifts to charity for life, or for other periods of time, using cash or assets that have not appreciated in value, or when appreciation falls within current exemption amounts, is still a viable planning tax strategy. Currently there are no proposals outstanding that would diminish the longstanding value of a split-interest gift to charity. President Biden’s 2022 budget proposal would not tax gains on gifts of appreciated assets to fund a CRT by the donor, if the gift to the CRT by the donor is completed before the end of 2021.
Testamentary Gifts to Charity: The unlimited federal estate tax charitable deduction still exists. This charitable estate tax deduction could become important (again) if an individual’s applicable exemption amount drops from the current $11.7 million to a lower amount, like $5.0 million, or possibly even lower, such as the $3.5 million exemption Bernie Sanders has proposed.

Conclusion: No one knows how Congress will respond to the many tax law bills before it, or how it will proceed to fund the 2022 federal budget. Some of these tax law proposals may well become law, maybe as early as December 31, 2021. For those individuals who are charitably inclined, they may want to consider implementing some of their charitable planning strategies now and not wait to see what Congress comes up with under the guise of ‘tax reform.’ In recent years individuals who had charitable bequests in their Wills and Trusts were encouraged to accelerate those testamentary charitable gifts into lifetime charitable gifts when the donor’s applicable exemption amount sheltered their estate from federal estate taxation, thus making the testamentary charitable estate tax deduction irrelevant, yet a lifetime charitable gift could reduce their taxable income. That approach still has validity, even if the applicable exemption amount is reduced in future years, due to the probable increase in federal income tax rates. Acting now to fund split-interest charitable trusts (CRTs) would avoid the deemed disposition rule on funding the CRT, and it would also remove the value of the transferred assets from the donor’s taxable estate should applicable exemption amounts drop, or federal estate tax rates increase. Its something to think about for individuals who are charitably inclined.