The House Ways and Means Committee’s markup of the budget reconciliation bill in mid-September left out some of the most punitive tax proposals floated by the Biden administration earlier this year. Of course, the Senate has yet to weigh in with its own language, so there is plenty of uncertainty about what will be part of the final bill coming out of Congress.
In the meantime, here’s what you need to know about the proposals as they relate to charitable givers.
Changes to the Charitable Giving Deduction May Fall to the Wayside
When he was campaigning for president, one of Joe Biden’s most unfortunate proposed changes to the tax code was the potential limit of the current tax deduction for itemized deductions, which would include charitable giving. Instead of keeping it at 37% for high-income earners, candidate Biden proposed decreasing the tax deduction benefit to 28% for those in higher-income tax brackets (as well as for most other miscellaneous itemized deductions).
So, for every $100,000 a high-income taxpayer donates, they would have received $28,000 in tax savings instead of the $37,000 they’d receive under existing law if they are in the 37% bracket. This would have been a significant departure from current law.
While it is true that not all charitable giving is directly tied to federal tax deductions, the fact remains that the current administration may be flirting with “unintended consequences” — something that worries many economists — and the negative affect that flirtation could have on one of the United States’ greatest assets: its robust and active charitable sector.
The good news is that proposal didn’t make it into Biden’s updated budget plan, released by the Treasury Department on May 28, known as the Green Book. And the House Ways and Means Committee’s markup didn’t include that proposed change either, but it remains on the table, and the Senate Finance Committee has yet to reveal how it feels about this change. So, it’s necessary to be cognizant of this possible threat to charitable giving.
So, What Else Could Be Coming Next?
Aside from charitable giving, there are a number of important changes proposed in the different tax plans floating about Capitol Hill right now. There’s no telling what the final budget bill will end up including, but it’s worth considering how to prepare for the possibilities — whether they may be higher tax rates on the top earners, a bump up in capital gains tax rates or changes to our estate tax system.
While the details in these tax proposals may seem overwhelming, there are some options whereby one might mitigate one’s own tax liability under some of these proposed tax hikes. Unsurprisingly, as is often the case, there are a number of exclusions that may apply to your particular situation.
Accelerate Gain Harvesting – Maybe
It might be too late to “harvest” any capital gains this year to avoid a possible rate hike, as any capital-gains tax increase that might pass is intended to apply retroactively to the 2021 tax year. Currently, long-term capital gains and qualified dividends are taxed at 20% for taxable income over $1 million. Under the Biden plan, however, taxable income of more than $1 million that’s generated from capital gains and qualified dividends would be taxed at the 39.6% rate. The House Ways and Means Committee’s plan, meanwhile, caps the top rate at 25%.
Whatever you decide to do to prepare for changes to capital gains tax rates, closely monitor and manage your capital gains and time your income realization accordingly. Moreover, if you — in consultation with your tax advisers — determine you should realize income from investment growth this year, consider decreasing your income tax liability by upping the amount of money you give to charity.
Perhaps, for example, you could make an enhanced contribution to a donor-advised fund, thus taking advantage of current tax deductibility rules while setting aside a pool of charitable dollars to fund organizations over subsequent years.
Use It or Lose It
This is likely the year to transfer large sums of money out of your estate and into trusts set up for your loved ones. Throughout 2021, taxpayers can cumulatively transfer up to $11.7 million free of estate and gift taxes to financial vehicles like charitable remainder trusts.
Under a plan floated by Sen. Bernie Sanders, this number would shrink dramatically — from $11.7 million to $3.5 million for wealth transfers upon a benefactor’s death. As a candidate, Biden campaigned on a similar platform, however, that wasn’t explicitly included in his American Family Plan, recently released as the Green Book.
The House, meanwhile, scaled back some of this proposed reduction in the estate-and-gift-tax exemption, opting instead to shrink the current inflation-adjusted $11.7 million exemption to $5 million, indexed for inflation, effective Jan. 1, 2022. Clearly, however, in either situation, parceling out your wealth to loved ones ahead of time would look to be a smart way to reduce the tax liability of your estate upon your death.
Defer Your Income
Assuming the new tax proposals are enacted, the creative minds of the financial services industry will likely identify new and adapt existing products to help clients defer income so as to avoid the more punitive tax increases and preserve more funds for posterity. I am confident, for example, there will be more information forthcoming from tax advisers near and far on charitable remainder trusts.
It’s Conversion Time – Perhaps
Consider, also, converting a qualified retirement account into a Roth IRA. While conversion often triggers an income event, it could be the perfect way to avoid top marginal tax rate hikes. Moreover, the 2020 CARES Act provision allowing one to deduct 100% of one’s adjusted gross income for charitable cash contributions (with some exclusions) has been carried over into the 2021 tax year.
Consequently, someone converting a qualified retirement account into a Roth IRA has the opportunity to protect some of that income from taxation if the taxpayer donates up to 100% of their adjusted gross income.
In closing, please remember this post is intended for educational purposes only and doesn’t take into account your personal and, therefore, unique situation. As such, each taxpayer should consult with his or her tax advisers before determining a course of action intended to mitigate the effects of forthcoming changes to federal income tax policy.