Biden Administration’s Proposed Tax Changes: What You Need to Know
In conjunction with the release of its infrastructure plan, the Biden administration shared a tax plan to help fund proposed spending. When might any changes go into effect, and what could be the implications for charitable giving?
Likelihood of Passage: Given the divided Senate and the current status of the infrastructure discussion, there is a lot of uncertainty about what will happen. Senator Joe Manchin has stated that he does not support passing the infrastructure bill through the reconciliation process, which would require 51 votes in the Senate. The Democratic party would need all 50 of its senators, plus Vice President Kamala Harris, to pass the tax changes through that method. Without Senator Manchin’s support, the Democrats would need a Republican to cross party lines for the vote.
If the bill were to somehow pass, analysts say any changes will most likely take effect in the 2022 tax year or even beyond. The timing would depend on the strength of the economy. I did not find any experts who state that any changes would be applied retroactively to prior tax years.
Pending changes: Some provisions of the current tax code, like individual income tax rates, will change even if Congress does nothing. The 2017 Tax Cuts and Jobs Act, which contained changes to income, gift, and estate taxes in ways that impacted charity, will “sunset” in 2025. When that happens, prior tax law will kick back in. Congress may want to take up taxes before then to have some control of future tax policies and to impact revenue and spending.
Finally, parts or all of this proposal may be intended as negotiating starting points. An estate planning attorney told me that the elimination of the step-up in basis at death, for example, has a “zero” chance of becoming law. So stay tuned, as any or all of these points may change.
For 2021: The December 2020 stimulus bill allows individuals in 2021 to deduct cash contributions made to certain public charities against up to 100% of adjusted gross income or AGI. In addition, that bill permits taxpayers who do not itemize their deductions to use a so-called “above the line” deduction for small charitable gifts, up to $300 for individuals and up to $600 for married couples filing jointly.
You probably already shared these opportunities with donors since they were first permitted in the March 2020 CARES Act. Continue any marketing and education you did to encourage donors to take advantage of the higher AGI limit and, for donors who make smaller annual gifts, share the benefits of above-the-line deduction options.
Biden’s Proposal- income and capital gains taxes: There are several items in the Biden tax proposal that could affect charitable giving. First, the administration proposes raising the highest marginal individual income tax rate to 39.6%, which is the level where it was set prior to the 2017 tax bill (and to which it will return if Congress does nothing in between now and 2025). The proposal would also increase the maximum capital gains rate for high earners: individuals earning $1M+ will pay 39.6% tax on capital gains. Right now, that maximum rate is 20%.[1]
If these two tax changes occur, charitable contributions in general, which can be itemized, and gifts of appreciated assets in particular may become more appealing. This is because the higher the tax rate, the greater the benefit that deductions may bring. While we know most donors do not give to reduce taxes, they may still seek to maximize the benefits of giving. Without knowing when any changes might take effect, though, some donors may consider deferring gift decisions until there is greater clarity.
Advisors are also talking about the potential uses of charitable remainder trusts to address increased capital gains taxes. For those with highly-appreciated capital assets, funding a CRT with appreciated stock can spread the capital gains tax payments over the lifetime of the trust and eliminate any gains that would be due on the portion of the trust that goes to charity.
Biden’s proposal- enforcement: part of President Biden’s infrastructure proposal would increase oversight of sophisticated taxpayers and instruments. This could include increased oversight of private foundations, which have to avoid “self dealing,” a category of prohibited behaviors that, if found, can trigger excise taxes and penalties.
Takeaways: Increased enforcement of private foundations may drive more donors to fund donor advised fund accounts, where the rules and penalties around self-dealing do not apply.
Biden’s proposal- estate planning: The Biden tax plan does not alter the current estate and gift tax exemption amount. If Congress does nothing, the exemption amount will return to the pre-2017 amount of $5M, adjusted for inflation.
Biden’s plan does propose a significant change to the concept of “basis” that will affect estate planning and deferred charitable gifts. “Basis” is typically the amount that you pay for an asset. The difference between your basis or purchase price and the amount for which you sell an asset is considered “capital gains.” This is the amount that is subject to tax.
Under current law, if you inherit an asset from a decedent’s estate, that asset receives a “step up” in basis: that is, the IRS deems your basis to be the asset’s fair market value on the date of the decedent’s passing. If, for example, you inherit a home from a loved one, you would receive it with a basis equal to the home’s fair market value on the date your loved one passed away. When you sell the home, you will have smaller capital gains and less tax to pay.
President Biden’s tax proposal modifies the step up in basis at death. Under his plan, the estates of single taxpayers may exempt up to $1M in capital gain, or $2M for married couples.
Takeaways: The average American family’s net worth is around $750,000, although median net worth is far lower, from roughly $168,000 for Gen Xers to about $250,000 for those age 65 and up.[2] So a tax change that will impact those with capital gains over $1M will not affect most people. This rule change would, however, affect high net worth individuals and families. To avoid giving inheritors highly-appreciated assets, they may specifically direct their executors to satisfy charitable bequests with the most appreciated assets that they own. In addition, wealthy individuals and families may donate more highly-appreciated assets to charity during their lifetimes so that their heirs do not have to pay capital gains taxes on them.
This proposal in particular is one that seems unlikely to pass. If it does, some speculate that charities will need to adapt by upping their ability to accept noncash gifts. A charitable remainder trust, testamentary this time, may help spread out capital gains taxes on highly appreciated property if this part of the proposal is enacted.
Change is in the air- don’t waste it. When tax changes loom, articles like this one proliferate to analyze the possible impacts. This drives donors to contact their advisors, and advisors similarly will use the news to communicate with their clients, just as nonprofits do.
The potential for change, then, is one more opportunity for your organization to become part of donors’ estate plans, reinforce the importance of existing estate gifts, and increase their impacts. Continue to communicate with your existing deferred gift donors and with deferred gift prospects to educate them about these changes, share impact stories, and request opportunities to speak with them about making a deferred gift. Never waste a chance to have these conversations at the time that donors are actually revising their estate plans.
[1] This does not include the 3.8% net investment income tax.
[2] Megan DeMatteo, “Here’s the Average Net Worth of Americans Ages 45 to 54,” CNBC, April 6, 2021. https://www.cnbc.com/select/average-net-worth-by-age-45-to-54/