Do You Expect a Spike in Income?
A Charitable Gift Can Mitigate Tax Consequences

Featured Article
January 2015

Any of several events could result in a spike in your income this year. While additional income is generally a blessing, it can have adverse tax consequences—which can be alleviated by making a certain type of charitable gift that in addition makes payments to you.

Possibly you plan to sell a depreciated rental property or a large block of stock, either of which would result in a significant amount of realized capital gain. Maybe you will get a large payout of deferred compensation or a significant bonus from your employer. Perhaps you are exercising stock options or receiving a balloon payment from an installment note.

Such spikes in income can have the following adverse tax consequences:

  • Part of your income may be taxed at a higher rate.
  • You may experience a loss of some of your itemized deductions.
  • There may be a phase-out of your personal exemptions.
  • Your capital gain and dividends may be taxed at a higher rate.

Surtax on Investment Income

The American Taxpayer Relief Act (ATRA) that was enacted at the beginning of 2013 imposed a 3.8% surtax on investment income (capital gain, dividends, and certain other investment income) when an individual taxpayer has adjusted gross income in excess of $200,000 or when a couple filing jointly has adjusted gross income in excess of $250,000.

If your highest tax bracket is between 25% and 35%, the standard tax rate on your capital gain and dividends is 15%. However, if your adjusted gross income exceeds the thresholds noted above, the rate would be 18.8%.

In the event your income is high enough to subject you to the maximum 39.6% income-tax rate, your capital gain and dividends would be taxed at 23.8% (20% rate plus the surtax). The tax rate on your gain could be still higher if you are selling either real estate that has been depreciated or tangible property that has appreciated in value.

The Charitable Strategy

If a spike in income is resulting from a sale of real estate or stock, consider a charitable strategy that would keep your adjusted gross income below the threshold levels—and thus prevent the surtax on the capital gain from the sale and on the dividends from your other stock investments. The strategy is to transfer the property to a charitable remainder trust, which is an instrument that pays you and/or another beneficiary income for life or a term of years, with the remainder going to a charity such as our organization.

Example: Roger and Alison, both aged 65, plan to sell a rental property appraised at $400,000 with an adjusted cost basis of $150,000. If they did not sell the property, their adjusted gross income would be $230,000. By selling the property, they increase their adjusted gross income above the threshold level and subject themselves to the 3.8% surtax. Because they have depreciated the property, part of the capital gain would be subject to a 28.8% tax (25% rate on gain attributable to depreciation plus the 3.8% surtax).

However, none of the capital gain is added to their income and subject to tax when they transfer the property to a charitable remainder trust. And the trust, being tax-exempt, can sell the property without taxation of gain. A portion of trust payments received by Roger and Alison each year may be capital gain, but even so they stay below the adjusted gross income threshold that would subject them to the surtax. Moreover, they realize an immediate income-tax deduction—and receive income for life!

If Roger and Alison plan to sell a block of appreciated stock instead of rental real estate, they would realize similar tax benefits. In either case, they can make a meaningful charitable gift while reducing taxes and providing future income security.

If you are expecting a spike in income this year, please contact us about a plan that fits your situation and that could mitigate the adverse tax consequences you would otherwise experience.


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