By Ruder Ware Alumni
October 19, 2006
The Pension Protection Act of 2006 contains important provisions designed to encourage charitable contributions by individuals. At the same time, Congress was concerned about reining in what it perceives as abuses of the charitable contribution deduction, so the Pension Act contains a number of restrictions on your ability to obtain a deduction for donations of certain kinds of property. With proper planning, however, you should be able to take advantage of the new deduction opportunities, while maximizing the tax benefits of any gifts that are subject to the new restrictions.
Below is our summary of the charitable contribution provisions of the Pension Act, including some suggestions for how these provisions can be used to your advantage.
Tax-Free Distributions from IRAs
Effective for a two-year period (January 1, 2006-December 31, 2007), distributions made from an IRA to a qualifying charity are excluded from the income of the IRA owner. The owner must be at least age 70 to take advantage of this provision, and the amount excluded is limited to $100,000 per year. This provision removes a number of impediments that stood in the way of IRA owners who wanted to give all or a portion of their IRA to charity. Under the usual rules, a gift from an IRA to charity is treated as a taxable distribution to the owner, who then has to claim an itemized deduction for the gift. Treating the gift as a distribution has adverse tax consequences to the owner, including the possibility of the alternative minimum tax and the loss of itemized deductions and personal exemptions. And because the deduction is limited to 50% of the IRA owner’s adjusted gross income, often the owner does not get a full deduction in the year of the gift.
These impediments are removed for qualifying owners by treating the distribution as an exclusion from income, rather than as a deduction. Because there is only a two-year window, you should consult with us if you would like to make such a gift and will be at least age 70 during 2006 or 2007, so we can help you obtain the maximum tax benefit.
Limitation on Contributions of Household Goods and Clothing
Many taxpayers take advantage of the charitable contribution deduction by making gifts of used clothing and household goods. Due to concern about abuses of this type of deduction, the Pension Act provides that the deduction will be allowed only if the donated clothing or household goods are “in good used condition or better.” This provision is effective immediately. It is not clear what Congress meant by “good used condition or better” and it is expected that the IRS will be issuing guidance in this area.
Fortunately, the limitation on “good used condition” does not apply to gifts of food, art objects, jewelry, gems, or collections, as well as to individual items of clothing or household goods with a value of $500 or more that is supported by an appraisal.
Limits on Deduction of Cash Gifts
New recordkeeping requirements in the Pension Act will probably have the effect of disallowing a deduction for small gifts of cash. Under the Pension Act, any gift of money (by cash or check) may be deducted only if a bank record or a written acknowledgement from the donee organization supports it. This provision is effective for taxable years beginning after August 17, 2006, and may discourage small cash gifts, such as those to a disaster relief organization, a synagogue, or church.
Cut-Back on Deductions for Gifts of Tangible Personal Property
Under prior law, a donor of a gift of tangible personal property (for example, a painting or other work of art) could deduct only the tax basis of the property (rather than its higher fair market value) if the donee charity did not use the property in its exempt function. This restriction is extended by the Pension Act to apply to property that is disposed of by the charity within the same year that it was received. In addition, if the charity disposes of the gifted property in a subsequent taxable year, but within three years of the gift, the IRS will recapture the tax benefit that the donor received in the year he made the gift. These adverse consequences can be avoided if the charity provides a certification that its original intended use of the property became impossible or infeasible.
Restrictions on Gifts of Fractional Interests
Gifts of fractional interests have been an accepted planning technique for donors of tangible personal property such as artwork or collections. In a typical transaction, the owner of a painting gives a museum a gift of a 50% interest in the painting, which allows the donor to retain possession of the painting for six months out of the year while still getting a deduction for 50% of the value. The donor would still be able to make additional fractional gifts of the painting to the museum in future years (or at his death), until the museum held 100% ownership.
The Pension Act imposes significant limitations on this type of planning. Although a donor may still make fractional gifts, they have become subject to the following restrictions: (1) the donor must own 100% of the property before making the first gift; (2) subsequent gifts of fractional interests must be valued as if made at the time of the initial gift (thereby eliminating the benefit of any appreciation in the property); and (3) any tax deduction will be recaptured (with interest) if the donee does not receive 100% of the property by the earlier the donor’s death or 10 years after the initial gift.
Contributions to Donor-Advised Funds
The Pension Act contains a number of restrictions on so-called “donor-advised funds,” which are separately identified accounts funded by a donor and held by a charity (typically a community foundation) for future distribution at the donor’s recommendation. The Pension Act provides that a contribution to such a fund will not be deductible unless: (1) the sponsoring organization for the fund is a charity; (2) the sponsoring organization is not a particular variety of a supporting organization (we will be glad to explain to you the nature of a supporting organization); and (3) the sponsoring organization provides the donor with a written acknowledgement of the gift that explains that the sponsoring organization has exclusive control over the use of the gift.
The purpose of these restrictions is to discourage gifts to organizations that allow the donor excessive control over distributions from the fund. It should have no impact on gifts to mainstream donor-advised funds.
Increased Deduction for Conservation Contributions
Taxpayers are allowed a deduction for the fair market value of certain partial real estate interests that are donated to charity for conservation purposes. Usually, these donations take the form of conservation easements, but they also include gifts of property without the mineral rights and gifts of a remainder interest in real property.
Under prior law, taxpayers could deduct such gifts only to the extent of 30% of their adjusted gross income in the year that the gift is made. The excess could be carried over for another five years.
The Pension Act, in another provision that applies only in 2006 and 2007, increases that deduction limit to 50% of adjusted gross income, thereby allowing more of the gift to be deducted in the year that it is made. If, however, the donor is a farmer or rancher, the limitation is increased to 100% of adjusted gross income, provided that the gift does not place any restriction on the ability to use the property for farming or ranching. In addition, regardless of the identity of the donor, the carry forward period is extended to 15 years, ensuring sufficient time to deduct a very large gift of property.
This is an area where you should seek experienced counsel before making a gift. The highly technical requirements for these gifts, coupled with the limited two-year window, leave little room for error.
Increased Requirements for Gifts of Historical Facade Easements
Recent Congressional hearings examining excessive deductions for gifts of historical facade easements led to restrictions in the Pension Act on the deduction for such gifts. Under the Pension Act, no deduction is allowed for a gift of a facade easement unless: (1) the easement preserves the entire exterior of the building; (2) the deduction is reduced by a pro rata portion of any rehabilitation credit claimed for the building; (3) the donor includes a qualified appraisal, photographs, and a $500 filing fee with the tax return on which the deduction is claimed.
Limits on Contributions of Taxidermy
Congress also has heard testimony regarding excessive deductions claimed for charitable gifts of big game mounts and other types of taxidermy. Taxpayer abuses in this area led to restrictions in the new law. The Pension Act limits the deduction for gifts of taxidermy to preparation costs. This limitation, however, applies only to a person who prepared or paid for the taxidermy property. Thus, a subsequent owner may still claim a fair market value deduction, as long as the property has been held for at least one year.
Increased Penalties for Valuation Misstatements
Congress also used the Pension Act as an opportunity to reexamine the penalties imposed on taxpayer overstatements of the value of gifted property. The Pension Act reduces the threshold for imposition of the 20% and 40% tax penalties on valuation misstatements for charitable contribution purposes. The penalties are imposed when a taxpayer significantly overstates the value of contributed property. Formerly, the 20% penalty was imposed when the overstatement of value was 200% or greater, but that threshold is now reduced to 150%. Before the Pension Act, the 40% penalty was imposed when the overstatement was 400% or greater; that threshold is reduced to 200%. In addition, a new penalty is imposed on any appraiser who is responsible for the overstatement.
As you can see, the Pension Act made a number of important changes, several which may have an impact on your charitable giving practices. Please don’t hesitate to consult any of the attorneys in the Trusts & Estates Practice Group of Ruder Ware before acting on any information contained in this article.
This document provides information of a general nature regarding legislative or other legal developments, and is based on the state of the law at the time of the original publication of this article. None of the information contained herein is intended as legal advice or opinion relative to specific matters, facts, situations, or issues, and additional facts and information or future developments may affect the subjects addressed. You should not act upon the information in this document without discussing your specific situation with legal counsel.
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