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The Biden administration has been pitching the President’s new tax plan as a boon for nonprofits — since it is likely to inspire wealthy Americans to give more of their assets to charity to offset their tax bills.
But perhaps the biggest benefit of the President’s plan would come to nonprofits that have extensive planned giving programs — especially those that offer vehicles that provide income to the donor.
Here’s why: Biden is proposing increasing income taxes on those earning more than $400,000 annually, while also increasing capital gains taxes to the same maximum rate of 39.6%.
If his proposal passes, folks earning above that threshold would likely shift money out of stock market equities in search of returns that won’t be taxed so high — or not taxed at all.
Biden’s folks say they expect wealthy donors to give stock to charity rather than pay tax on the gains. But the real benefit to these donors would more likely come through charitable gift annuities and charitable remainder trusts.
These vehicles deliver fixed or variable payments — with the understanding that they will ultimately benefit the charity of the donor’s choice.
Charitable gift annuities make payments to one or two people for their lifetimes. Those payments usually go to the donors, but they can also be designated for someone else. (Think of a child helping a parent, a parent helping a child or a sibling helping a sibling.) The payments are fixed for life.
Charitable remainder trusts also pay income for life, but can be set up for a term of years instead. Trust income is fixed in the charitable remainder annuity trust; or variable based on an annual revaluation of assets, in the charitable remainder unitrust.
Payments from these charitable vehicles, while considerably lower than recent large-cap equity returns, carry a significantly less burdensome tax hit.
Payments from charitable gift annuities are very often tax-free for a number of years, corresponding to your donor’s life expectancy. Depending on their age, they could see the next tax law change reduce ordinary income tax rates before their payments convert from tax free to ordinary income. Of course, the next tax law change could increase ordinary income rates. But donors are still very likely to enjoy a period of tax-free payments.
While the donor receives immediate incentives for giving through these vehicles, they are a longer term play for nonprofits — receiving a gift of cash after the death of the donor or those who are receiving payments from the vehicles.
When a charitable remainder trust is invested smartly, trust income will be tax free to those receiving it. When a remainder trust earns and distributes tax free income, it remains tax-free in the hands of those it’s distributed to — think of municipal bonds and tax-free exchange traded funds.
Here’s an interesting scenario that runs contrary to the typical advice of funding a charitable remainder trust with appreciated stock. You might see forward-looking donors selling appreciated stock pre-tax law change and funding their charitable remainder trust with the cash from the sale.
Under this tax-rate play, they’ll have to pay the current, lower capital gain tax on the sale (whether short term or long term), but their trust will avoid incurring capital gain and having to distribute it after the capital gain rate is increased to near 40%. Instead, the trustee will invest the funding cash in tax-free investments, thus avoiding any distribution of capital gain had the trust been funded with the appreciated stock.
Gift annuities and remainder trusts also qualify for federal income tax charitable deductions, helping to lessen the sting of higher income tax rates on high earners. If the full deduction cannot be enjoyed in one year, it can be carried forward for as many as five additional (higher tax) years.
President Biden also proposes to widen the net on the federal estate tax, making more estates susceptible to taxation and increasing the rates. That may trigger increased interest in charitable lead trusts, which high-net-worth donors — those wealthy enough to give away income to charity — can use to transfer assets to heirs at reduced tax cost.
Those earning over $400,000 a year likely won’t move all their money out of equities. But passage of the Biden tax plan — or something close — will prompt them to realign their portfolios and move some money out of the stock market.
Those moves can create a ripple effect of opportunities for nonprofits that have expansive planned giving programs.
If you’re responsible for such a program, now is a good time to begin having conversations with donors about the possibilities if Biden’s proposal becomes law. It’s also a good time to review your planned giving marketing materials to see if it’s time to update them.