Financial planning knowledge to help you better serve your clients.

Split-interest gifting has long been a staple of charitable tax planning for affluent individuals, where assets are “split” between individual beneficiaries (e.g., the donor themselves or their family members) and charitable beneficiaries. At its core, the appeal of such split-interest vehicles – particularly the ‘charitable remainder’ type – is the opportunity to claim a current tax deduction now, for a donation that can still generate income for the desired income beneficiaries in the years to come… paired with a remainder that only goes to the charity in the potentially-distant future.

The caveat, though, is that the charitable tax deduction for a charitable remainder trust and similar split-interest vehicles is determined by calculating the present value of the income interest that will be left to non-charitable beneficiaries, and subtracting that value from the upfront contribution to determine the value of the remainder. Which means the lower the interest rate, the higher the value of the non-charitable income interest, and the lower the value of the upfront charitable deduction. Which has diminished the desire to establish CRTs and other split-interest vehicles in the current low-rate environment.

However, Pooled Income Funds (PIFs) operate under slightly different rules, which can make them somewhat more appealing for split-interest giving at low yields. Functionally, PIFs are similar to CRTs, in providing an income interest to some non-charitable individuals (e.g., the donor or their family members) and the remainder to a charity. However, while CRTs typically pay out a fixed stated dollar amount or percentage of the trust, PIFs are assumed to pay out whatever their income actually will be (based on whatever their returns have been for the preceding 3 years). Which means when interest rates and projected returns are low, so too is the assumed payout rate from the PIF… allowing for a larger charitable deduction for the split-interest gift (albeit at a ‘cost’ of not necessarily generating as much income for the income beneficiaries).

For new Pooled Income Funds that have been formed, though, there is no 3-year history to determine an assumed return, and as a result the Treasury Regulations state that new PIFs are expected to use an assumed rate of the IRS 7520 rates reduced by 1%... producing an even lower interest rate assumption in the current environment, and an even higher charitable deduction. Except to the extent that the new PIF – or NPIF – actually earns a higher return in the future, it can pay out a higher rate to its income beneficiaries, even after “locking in” the charitable deduction at the initial lower-interest-rate assumption, allowing for the best of both worlds (a favorable potentially-higher payout rate to income beneficiaries and a favorable lower-interest-rate assumption for the charitable tax deduction)!

In fact, some charities are now establishing NPIFs on a rolling basis specifically to allow a steady flow of new donors to take advantage of the new rules for more favorable charitable tax deductions. And are incorporating other more-flexible provisions into their PIF documents to further attract donors to participate (for which the sponsoring charitable institution hopes to be the charitable remainder).

Unfortunately, though, because NPIFs are so ‘new’ themselves, there is no centralized directory of sponsoring charities and opportunities, requiring those interested to explore with their own charities of choice (and the associated Planned Giving Departments). Nonetheless, giving the substantial additional tax benefits that may be available, those who have an interest in split-interest charitable giving (e.g., via a Charitable Remainder Trust) should at least explore whether their charity of choice may be sponsoring a New Pooled Income Fund to use or a better charitable tax deduction instead!?
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When investments appreciate in value, their capital gains are subject to preferential tax rates, which were first established to incentivize taxpayers to invest their available savings for growth. However, President Joe Biden’s recently proposed American Families Plan, calling for substantial tax reform, includes a number of changes that would dramatically reshape the taxation of capital gains. In particular, the proposal would – at least for high-income individuals – eliminate the preferential rates for long-term capital gains, reverting their tax rate to the top ordinary income tax bracket (which itself would rise from the current 37% to a new 39.6% rate under the proposal).

Notably, the new 39.6% rate on long-term capital gains would only apply directly to taxpayers with income in excess of $1 million, allowing most to avoid the new capital gains bracket. However, because assets can appreciate substantially over very long periods of time, and potentially be taxed all at once in the year they are ultimately sold, the newly proposed capital gains tax rate could also potentially impact other taxpayers who don't annually earn anywhere near $1 million, but do have a once-in-a-lifetime (or few-in-a-lifetime) taxable event(s), such as the sale of a business, that can temporarily push their income over the $1 million mark (if only due to the capital gains event itself).

While the recent Biden budget proposal for Fiscal Year 2022 assumes the capital gains changes are made retroactively to April 2021, the reality of both the political climate and the practical challenges associated with such a retroactive change means that the most likely outcome would be a January 2022 effective date for any changes. Accordingly, business owners who are considering the potential sale and exit of a business – that may potentially have a ‘lifetime’ of growth all taxed in a single year of sale – will seriously want to consider liquidating the business before year-end, in an effort to ‘harvest’ capital gains at current 20% top capital gains tax rates, and avoid potentially substantial capital gains income from being subject to the proposed 39.6% top tax rate in the future (which at the margin, is a 19.6% tax rate savings on what could be one or several million dollars of appreciated business value!).

Additionally, business owners selling in 2021 whose sales may qualify for the installment method may wish to proactively opt out of such treatment, and instead report all gain from the sale in 2021, to avoid having capital gains spill into future years, where they may again be taxed at the newly proposed higher rate. Opting out of such treatment, however, could leave certain business owners with liquidity challenges that should be proactively addressed.

Ultimately, the price of liquidating capital gains (or having them treated as liquidated upon death) is likely about to be dramatically increased for high-income taxpayers (and others with highly appreciated assets that they will sell). And while most will be able to avoid the capital gains exposure – simply because they don’t earn $1M+ per year in the first place – those contemplating the sale-of-a-lifetime (e.g., a business whose value has been built over years or decades) in the coming years will want to seriously consider whether to accelerate (or not) the sale in 2021 given the sizable one-time tax savings that may be available! Which, notably, not only includes the clients of financial advisors, but even financial advisors themselves considering retirement and the potential sale of their own advisory firms!

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