In some cases, the answer is yes!

There is still time for year-end tax planning.

When you look at a form 1040, and its accompanying Schedule A – Itemized Deductions, you see that there are only a few categories of deductions that can be large amounts.

These big categories are:

·         Medical and Dental Expenses

·         Taxes Paid

·         Interest Paid

·         Gifts to Charity

·         Casualty and Theft Losses

Generally speaking, the only one of these categories that people will voluntarily consider is Gifts to Charity.

And within that category there are a number of opportunities to reduce taxes significantly.

In this post, we take a quick look at the first of four of the most important ways to use charitable giving to generate tax savings.

Section 642 – Can Your Client Actually Make Money By Giving it Away?

Surprisingly, yes.

For certain clients, the proper use of Section 642 before the end of this year, 2023, can actually earn the client money, even after accounting for the charitable gift.

For example, consider a high income client in California who also owns $10 million of zero basis stock. The client and his wife are both 56 years old. If they sell the stock, they will face a combined federal and state tax rate of 37.1%, or $3,710,000 on the sale. That means if they sell, they would keep just $6,290,000 after tax.

Now suppose that instead of selling, they contribute the stock to an appropriate Sec. 642 trust. Because of the way the deduction calculations work, that contribution will generate an income tax deduction of a bit more than $5 million.

The income tax deduction can be used against ordinary income for both federal and California taxes.

The top federal rate is 37% plus 3.8% net interest income, for 40.8% total. To that add California’s top rate of 13.3%, for a total of 54.1%.

For a person (or couple) facing 54.1% tax, a $5 million deduction is worth about $2.7 million (or 54.1% of $5 million).

So, the client gives away an asset with an after-tax value of $6,290,000 to gain a benefit of $2.7 million. What’s so great about that?

The answer is that they keep an asset worth about $6.5 million after tax!

Let’s consider the comparison.

Either the couple does nothing, in which case they keep the $10 million asset with an after-tax value of $6,290,000.

Or, they give the $10 million to an appropriately structured 642 trust. This contribution generates an income tax deduction worth an after-tax $2.7 million. And they retain the right to receive income from the 642 trust for the rest of their lives.

If we assume that income averages 7%, and is subject to an average tax rate of 35%, the present value of that income stream using a 7% discount rate, is about $6.5 million.

So, by giving it away, they gain an after-tax value of $6.5 million plus $2.7 million, or about $9.2 million.

Only Ten Weeks Left for this Once-in-a-Lifetime Deal

This extremely favorable result – that a person can actually make money on a net after-tax basis by giving it away – is the result of highly unusual conditions. And the opportunity will vanish, like Cinderella’s chariot, at midnight on December 31, 2023.

The anomaly is the result of the rules for calculating the deduction on new 642 trusts. The deduction is computed, approximately, by using a set of rules provided by the tax law to calculate the present value of the principal in the trust at the end of the trust term.

As you will recall, a present value is calculated by dividing a future value by the sum of one plus the discount rate, and that sum raised to the power of the number of years.

Here’s an example. The present value of $1 million in 30 years, at a discount rate of 5%, is about $230,000. This is $1 million divided by 1.05, after 1.05 has been raised to the power of 30.

But if we use a low discount rate, such as 2.2%, the present value of $1 million in 10 years is over $520,000.

The charitable deduction for a gift to a 642 trust is calculated in a similar way to how present values are calculated.

Today, the yield on the 30 year US Treasury is about 5%.

But because of the way the rules work, for the remainder of 2023, people can calculate the deduction for contributions to new Sec. 642 trusts using the very low rate of 2.2%.

Being able to calculate a deduction using 2.2%, when US Treasuries are yielding 5%, is a once-in-a-lifetime opportunity, that can be worth big money to people able to take advantage of it.

Call Today if You Have a Client Who Might Be Able to Use This

This unique opportunity is not for everyone. But where it makes sense, it is simply a gift. To learn more, call us at (703) 437-9720 and ask for Katherine or Connor, click here to request info, or email us at [email protected].