Recent Tax Law Changes Affect Charities, Donors, IRA Accounts
 
August 22, 2006
 
Richard Sills - Washington

Recent changes in the tax law may affect your financial planning. Some of these planning opportunities are available only if certain conditions are met, and some are in effect only for a limited period of time. The following is a brief overview of some of these changes which you may want to discuss with your attorney.

• Qualified retirement plan accounts may be “rolled over” income-tax-free at death to inherited IRAs by non-spousal beneficiaries. Under prior law, only a surviving spouse qualified for a tax-free rollover to an inherited IRA account. After 2006, this tax advantage will be available to any other beneficiary of a qualified retirement plan who inherits benefits upon the participant’s death, such as a child, or a trust for a child’s benefit. It appears that this “rollover” will enable the new beneficiary of the inherited IRA to defer income tax on the earnings of the account until he or she reaches age 70-1/2 and is required to receive minimum distributions.

• An IRA owner may make gifts to charity directly from his or her IRA account, without causing the distributions to be included in income. This change applies only to IRA owners at least 70-1/2 years of age, and permits transfers up to $100,000 per year in 2006 and 2007. Under prior law, the account holder would have to include that amount in income, and then would be entitled to a charitable contribution deduction for the gift to charity, but due to various limitations on the use of itemized deductions, there was no assurance that the charitable gift would offset the income. As a result of not including the distribution in income, the donor has a lower adjusted gross income (AGI), and is less likely to lose other tax benefits that depend on AGI. This change also helps donors who use the standard deduction. Amounts transferred from the IRA to charity will count in satisfying the minimum required distribution for that year. For purposes of this rule, the transferee charity may not be a supporting organization, a private foundation, or a donor-advised fund.

• Starting in 2006, the net unearned income of a child under 18 will generally be taxed at the parents’ highest marginal tax rate. Previously, this rule applied only to children under age 14. This change reduces the effectiveness, for income tax purposes, of intra-family transfers of income-producing property from high-bracket parents to their minor children. (In 2006, the first $1,700 of a minor’s income is generally exempt from this rule.)

• Exempt organizations must file annual information returns with IRS even if gross receipts are less than $25,000. Previously some organizations with gross receipts under $25,000 were generally exempt from annual reporting requirements.

• Tax benefits arising from a gift of a partial interest in tangible personal property (such as a gift of art work to a museum) are now subject to new time limits. Charities receiving a fractional interest in an item of tangible personal property must take complete ownership of the item within 10 years of the initial fractional contribution or by the death of the donor, whichever is first. Also, the charity must have (i) taken possession of the item at least once during the 10-year period as long as the donor remains alive, and (ii) used the item for the organization’s exempt purpose. If these requirements aren’t met, all tax benefits are recaptured, plus interest and a 10 percent penalty.

• Liberalized charitable deduction rules apply to (1) businesses that donate food inventory to a charity, (2) corporations that contribute book inventory to public schools, and (3) qualified conservation contributions of land. For the first two items, the change consists of extending through 2007 a tax benefit that was to have expired. For certain qualified conservation contributions, deductions are allowed up to 50 percent of the donor’s contribution base (rather than 30 percent), and carryovers are allowed for up to 15 years.

• If a taxpayer deducts the fair market value of contributed property based on the representation that the donee will use it for exempt purposes, that tax benefit will be subject to recovery if the donee sells it within three years of the contribution and fails to certify the “exempt purpose” use. This may affect car donations, because the deduction is limited unless the car is used for an exempt purpose of the donee charity.

• New limits imposed on charitable contribution deductions for contributions of clothing and household items. A charitable deduction will be denied if the clothing and household items aren’t in good condition or better. The IRS may deny a deduction for any item with “minimal monetary value.”

• For private foundations, the definition of net investment income subject to excise tax has been broadened to include capital gains, annuities and other similar investment income.

• Penalties increase for various charity-related misdeeds. A recent law change doubles the excise taxes applicable to certain activities by public charities, social welfare organizations, private foundations and exempt organization managers. Also, it lowers the thresholds for imposing accuracy-related penalties on a taxpayer who claims a deduction for donated property for which a qualified appraisal is required.

• Donors must now maintain records even for small charitable contributions. When money is given to charity, regardless of the amount, the donor must maintain a cancelled check, bank record, or receipt from the donee organization showing the name of the donee organization, the date of contribution, and the amount of the contribution.

• The IRS is focusing on donor-advised funds, sponsoring organizations (such as community foundations) and supporting organizations. The IRS will undertake a study of donor-advised funds and of supporting organizations, to determine whether they are operating in a manner consistent with the purposes or functions constituting the basis for their tax-exempt status. Donor-advised funds will be prohibited from making grants to individuals, or to any entity if the payment is not for a charitable purpose. Penalties will apply if the donor, advisor or related parties receive more than incidental benefits from a donor-advised grant. Also, an “excess benefits” tax will apply to a grant, loan, compensation or similar payment from a donor-advised fund to a donor, advisor or related party (as defined), or from a supporting organization to a substantial contributor or a related person. New excess business holdings rules apply to donor-advised funds and Type III supporting organizations that are not “functionally integrated” with the supported charity. Both Form 1023 and Form 990 will require more disclosure with regard to donor-advised funds.

• Deductions for donated taxidermy property equal the lesser of basis or fair market value, but under the new law, basis is limited to the cost of preparing, stuffing and mounting an animal. The cost of the safari to an exotic location will no longer be deductible.

• Charities must report to the IRS acquisitions of interests in certain life insurance contracts for a two-year period. During that period, the IRS will study the issue to determine whether acquisition of life insurance contracts in which private investors also have an interest is consistent with the charities’ tax-exempt purposes.

For more information, e-mail Richard P. Sills at richard.sills@hklaw.com or by calling toll free, 1-888-688-8500.