Business as Unusual

From a philanthropic perspective, 2017 has been a year of “business as unusual.” 

The year began with the inauguration of a new administration promising an unprecedented package of legislation that would replace the nation’s health care system with a less expensive approach offering more benefits, address the nation’s infrastructure challenges and, at the same time, provide sweeping tax cuts for everyone.

Those working with individuals contemplating larger charitable gifts either as isolated transactions or as part of a broader estate and financial plan began the year with uncertainty. Would there be a charitable deduction in the future? Would the deduction survive but be capped in some way? Would estate and gift taxes be repealed? Would qualified appreciated assets continue to be deductible at fair market value? 

Tax Reform

For the first several months of the year, Congress wrestled with the health care issue before abandoning it after two abortive attempts. Congress then turned its attention to tax reform. That process began with a number of competing plans—all put forth by various segments of the majority party.  

As the late summer and fall progressed, it became clear that the blueprint for tax reform appeared to be the 2014 House Ways and Means plan known as the “Camp Proposal.”

As of early December, both the House and Senate had passed bills that significantly lowered corporate tax rates while adapting a modified flat tax approach on the individual side. Both bills eliminated most deductions, including those for state and local taxes, with the exception of the charitable deduction and mortgage interest deductions (with different caps on mortgage interest) and state and local taxes with the exception of property taxes with a $10,000 cap.

Both the House and Senate tax writers were careful to exempt the charitable deduction from direct cuts and even increased the adjusted gross income (AGI) limit from 50 percent to 60 percent for gifts of cash.

So far, so good, for philanthropy and tax reform. But as always, the devil is in the details. While it’s true that both houses of Congress chose to retain the full charitable deduction and the mortgage interest and property tax deduction with caps (and a capped deduction for property taxes in the House bill), both houses eliminated personal exemptions and increased the standard deduction to $12,000 for individuals and $24,000 for married taxpayers. This is tantamount to a flat tax for most Americans as a significantly small number of taxpayers would find themselves with enough mortgage interest, property taxes and charitable deductions to itemize. The provision for up to a $10,000 deduction for property taxes in both bills, would, however, go a long way to restoring a “practical” charitable deduction for many middle and upper middle class taxpayers.

On the other hand, both houses of Congress voted to repeal the Pease limitation on itemized deductions. When combined with the fact that many higher income individuals have mortgage interest and other deductions that nearly, if not completely, clear the standard deduction hurdle, these taxpayers would continue to make their gifts from pre-tax dollars while the remainder of donors would be giving from after-tax dollars.

Above-the-Line Treatment

When it became clear in early November that tax cuts were being partially funded by new taxes on charitable giving by those who may have to earn $15,000 in pre-tax income to give $10,000 (in the case of a non-itemizing donor in a 33 percent marginal tax bracket), charities finally began mobilizing their attempts to have Congress backtrack and return tax incentives to the middle class. 

The leading contender to repair the damage that tax simplification threatens to visit on middle class giving was the so-called “universal charitable deduction.” Sometimes referred to as an “above-the-line deduction,” it’s in reality not a deduction but rather an exemption from AGI for amounts given to charity.  

Much like the traditional treatment of alimony and unreimbursed business expenses, this approach recognizes that, unlike mortgage interest, charitable gifts don’t represent a choice of ways to expend discretionary income, but rather, these gifts are income that’s foregone in favor of voluntarily funding societal needs that would otherwise be borne by government or not met at all.

As we went to press, Congress was engaged in the process of reconciling the House and Senate tax bills in conference, and the charitable community continued to push for the above-the-line treatment of charitable gifts. The issue may boil down not to whether there’s some relief in this form, but whether it’s subject to a floor based on a dollar amount or a more progressive approach through a percentage of gross income floor or whether there’s a ceiling carefully tailored to rescue middle income donors from the impact of the increased standard deduction that taxpayers benefit from whether or not they give to charity.

Looking to the Future

The most sophisticated donors and advisors have been contemplating the future under a number of potential scenarios. As the end of the year approached, many began to notice other factors that often influence the nature and scope of charitable gifts, including the rapid increase in real estate and other investment values during 2017.  

It became increasingly clear to many that gifts of securities and other qualified assets that had increased in value may never yield more tax benefits than if they were donated before the end of 2017. Many astute planners advised their clients to accelerate gifts that may be planned for future years into 2017. Not only would gifts made this year not trigger a capital gains tax on the increased value, but also, the entire value of the asset may be deductible against a higher tax rate than that in future years, perhaps never saving as much in taxes again.

Another byproduct of this strategy for those who believe a correction may be in the offing: The conservation of cash that will be available to buy back into the market at lower values without having to realize taxable gains to free cash to diversify through purchases of shares at bargain prices not seen since 2009.

In a similar vein, many thoughtful investors with philanthropic leanings took a fresh look at charitable remainder trusts (CRTs) and other split-interest gifts that allow for charitable deductions in 2017 against what may be higher rates than in future years while also cashing in gains free of capital gains tax. A CRT also offers a tax-free trading environment and a way to build a future source of income that could be taxed at more favorable rates than other income under the tier structure of income reporting from CRTs.

Early Trump proposals eliminated the federal estate tax while preserving the gift tax to prevent income splitting and other lifetime maneuvers designed to transfer unlimited amounts to heirs while living.

Both the House and Senate versions of tax reform double the current threshold of estate and gift taxes to $11 million for singles and $22 million for couples. The House bill retained the gift tax while repealing the estate tax in six years. The Senate bill retained both the estate and gift tax at the higher threshold.

In any event, it’s become clear to those planning large charitable transfers that the world of estate and gift tax planning was heading to the most rarified strata of American society, the 1/10 of 1 percent, or one out of 1,000 persons, who still needed to seriously consider the impact of federal estate taxes.  

This may, in fact, be the best news for those helping clients plan for the eventual transfer of their assets. In fact, this may usher in a golden age of estate planning—a world where clients can actually do what they would like to do without the artificial strictures imposed by a tax system that too often interfered with what people actually wanted to achieve.

The future of estate planning in general, and philanthropic planning in particular, may only be limited by the imagination of clients and advisors who are able to navigate the planning waters guided only by the desires of their clients.