President Biden will soon turn his attention to comprehensive income tax reform which is expected to result in higher taxes for wealthy individuals. For taxpayers who routinely give to charity, a donor-advised fund might be a useful tool to offset the anticipated increases in tax liabilities.
The Biden Administration campaigned with a promise to increase income taxes for wealthy individuals, defined by the campaign as those earning greater than $400,000 a year. With the recent passage of the American Rescue Plan Act, President Biden and Congress seem poised to now focus on comprehensive changes to current income tax law. The White House is concurrently rolling out a plan, coined “Build Back Better,” to gather support and consensus for the next phase of its economic agenda – a variety of programs that would invest in infrastructure, education, carbon-reduction, and working mothers. Build Back Better could cost an estimated two to four trillion dollars. Biden and his team believe the proposal to increase spending requires an agenda with a two-pronged approach, with the second being an increase in tax revenue to fund the desired infrastructure spending and protect the nation’s long-term financial stability. A sample of some of the income tax increases proposed by the Biden campaign are listed below:
· Decrease the top tax bracket from $622,000 to $400,000 and increase the top tax rate from 37% to 39.6%.
· Tax long-term capital gains and qualified dividends at the ordinary income tax rate of 39.6% on income above $1,000,000.
· Eliminate the step-up in basis for capital gains taxation.
· Cap the tax benefit of itemized deductions to 28% of value for those earning more than $400,000.
· Phase out the qualified business income deduction (Section 199A) for filers with taxable income above $400,000.
· Increase the corporate income tax rate from 21% to 28%.
For those individual taxpayers who are charitably inclined, the utilization of a donor-advised fund is an excellent strategy to offset income. A donor-advised fund acts as a charitable investment account used over time to support the charitable organizations you care about. You can establish a donor-advised fund by donating cash, appreciated securities, or non-publicly traded assets such as an interest in a private business. The donation is generally eligible for an immediate tax deduction, but gifts can be made from the donor-advised fund to charities you choose over the course of many years, perhaps even your lifetime. While you are deciding which charities to support, your donation can be invested, and the growth is tax-free. Essentially you are taking the tax deduction when it is most valuable to you by pre-funding your charitable giving for the future. As a bonus, all of your future giving can be organized and administered in a single place.
Funding a donor-advised fund is particularly useful during a high-income year. Examples of financial events that would cause a high-income year include selling a business, exercising stock options, receiving a large bonus, selling real estate, and rebalancing an account with concentrated low-basis positions. A portion of this income can be offset by funding your future charitable giving in a donor-advised fund. Assume you plan to sell your business for $10,000,000 in 2021 and your basis is low, which means you will realize significant capital gains when you file your 2021 tax return. You also plan to continue charitable gifting which has averaged $50,000 per year. Rather than give $50,000 to charities each year for the next ten years, you could fund ten years of gifting in 2021 by donating $500,000 to a donor-advised fund and create a $500,000 charitable deduction on your 2021 tax return to offset proceeds from the sale of your business. Gifts to charities can then be made in future years from your donor-advised fund.
If you find yourself in a high-income year due to a financial event, or a high tax year due to income tax reform (or both), consider discussing a donor-advised fund with your wealth advisor. There are additional charitable planning techniques, including the use of charitable trusts, that your advisor may wish to explore given your unique situation.