October 12, 2006 Update...

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PENSION PROTECTION ACT OF 2006:
CHARITABLE GIVING PROVISIONS FOR INDIVIDUALS
~ A letter from the Tax Director at Case | Sabatini ~

Background

The Pension Protection Act of 2006 contains important provisions designed to encourage charitable contributions by individuals.  The Act also contains a number of provisions that place new restrictions on deductions for certain contributions.  With proper planning, however, taxpayers should be able to take advantage of the new deduction opportunities, while maximizing the tax benefits of any contributions that are subject to the new restrictions.

Tax-Free Distributions from IRAs

Effective for a two-year period (January 1, 2006 - December 31, 2007), distributions made from a traditional or Roth IRA directly to a qualifying charity are excluded from the income of the IRA owner.  Special rules apply to limit the types of charities to which amounts can be transferred.  The owner must be at least age 70 ½ in order 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 previously stood in the way of IRA owners who wanted to give all or a portion of their IRA to charity.  Typically, a donation from an IRA to charity is treated as a taxable distribution to the owner, who then has to claim an itemized deduction for the donation.  This treatment has adverse tax consequences to the owner, including the possibility of the imposition of the alternative minimum tax and the loss of itemized deductions and personal exemptions.  Moreover, since the deduction is limited to 50% of the IRA owner's adjusted gross income, the owner often does not obtain a full deduction in the year of the contribution.

The Act removes these impediments for qualifying owners by excluding the distribution from income (rather than requiring a deduction to secure the tax benefit).  Because there is only a two-year window, you should consult with us if you would like to take advantage of this new rule and will be at least age 70 ½ during 2006 or 2007, so we can help you obtain the maximum tax benefit.

Taxpayers in Real Estate - 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 donations of property without the mineral rights and donations of a remainder interest in real property.

Under prior law, taxpayers could deduct such donations only to the extent of 30% of adjusted gross income in the year that the donation is made.  The excess could be carried over for another five years.  Under the Act, in another provision that applies only in 2006 and 2007, that deduction limit is increased to 50% of adjusted gross income, thereby allowing more of the donation to be deducted in the year that it is made.  In addition, the carry forward period is extended to 15 years, ensuring sufficient time to deduct a very large gift of property.

Cut-Back on Deductions for Donations of Tangible Personal Property

Under current law, a donor of tangible personal property (i.e., other than cash, securities, or intellectual property) is only permitted to deduct the tax basis of the property (rather than its higher fair market value) if the donee charity does not use the property in its exempt function.  This restriction is extended by the Act to apply to property that is disposed of by the charity within the same year that it was received.  The new rule applies only to property for which the claimed deduction is greater than $5,000.  Moreover, if the charity disposes of such property in a subsequent taxable year, but within three years of the donation, the taxpayer is required to recapture (i.e., report as ordinary income) the excess of the deduction over the basis of the property.  These adverse consequences can be avoided if, among other things, the charity provides a certification that its original intended use of the property became impossible or infeasible.

The Act applies to donations made and returns filed after September 1, 2006.

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 Act provides that the deduction will now be permitted only if the donated clothing or household goods are "in good used condition or better."  This provision is effective for contributions made after August 17, 2006.  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.

The limitation on "good used condition" does not apply to gifts of food, art objects, jewelry, gems, or collections, nor does it apply to individual items of clothing or household goods with a value of $500 or more that is supported by a qualified appraisal that is attached to the taxpayer’s return.

Limitation on Deduction of Cash Gifts

A donor who claims a deduction for a charitable contribution is required to maintain reliable written records regarding the contribution, regardless of the value or amount of such contribution.  For a contribution of money, the donor generally must maintain one of the following: (1) a cancelled check; (2) a receipt (or a letter or other written communication) from the donee showing the name of the donee organization, the date of the contribution, and the amount of the contribution; or (3) in the absence of a cancelled check or a receipt, other reliable written records showing the name of the donee, the date of the contribution, and the amount of the contribution.  For a contribution of property other than money, the donor generally must maintain a receipt from the donee organization showing the name of the donee, the date and location of the contribution, and a detailed description (but not the value) of the property.

In addition to the foregoing recordkeeping requirements, substantiation requirements apply in the case of charitable contributions with a value of $250 or more.  No charitable deduction is allowed for any contribution of $250 or more unless the taxpayer substantiates the contribution by a contemporaneous written acknowledgement of the contribution by the donee organization.  The acknowledgement is required to include the amount of cash and a description (but not value) of any property other than cash contributed, whether the donee provided any goods or services in consideration for the contribution, and a good faith estimate of the value of any such goods or services.

In general, if the total charitable deduction claimed for non-cash property is more than $500, the taxpayer is required to attach Form 8283 to his or her return.  In general, taxpayers are required to obtain a qualified appraisal for donated property with a value of more than $5,000, and to attach an appraisal summary to the tax return.

The Act generally extends the substantiation rules for property to the substantiation rules for money by providing that, regardless of the amount of money, applicable recordkeeping requirements are satisfied only if the donor maintains as a record of the contribution a bank record or a written communication from the donee showing the name of the donee organization, the date of the contribution, and the amount of the contribution.  The recordkeeping requirements may not be satisfied by merely maintaining other written records.  The new rule is intended to provide greater certainty, both to taxpayers and to the IRS, in determining what may be deducted as a charitable contribution, and is effective for contributions made in taxable years beginning after August 17, 2006.

Restrictions on Contributions of Fractional Interests

Contributions of fractional interests have been an accepted planning technique for donors of tangible personal property, such as artwork or collections.  For example, a taxpayer might give a museum a gift of a 50% interest in a painting pursuant to an arrangement in which the taxpayer retains possession of the painting for six months out of the year, thereby obtaining a deduction for 50% of the value of the painting.  The taxpayer then makes additional fractional gifts of the painting to the museum in future years (or at death), until the museum holds 100% ownership. 

Effective for contributions made after August 17, 2006, the Act imposes new limitations on this type of planning.  Under the Act, a donor may still make fractional gifts.  However, they are now subject to the following restrictions.  First, the donor must own 100% of the property before making the first gift.  Second, the value of subsequent gifts of fractional interests must be determined using the lower of the value as of the time of the initial gift or the value at the time of the subsequent contribution (thereby eliminating the benefit of any appreciation in the property).  Third, 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.

Taxpayers in Real Estate:  Historical Facade Easements

As stated above, a deduction is permitted for certain conservation contributions.  A facade easement may constitute a conservation contribution.  In general, a facade easement is a restriction the purpose of which is to preserve certain architectural, historic, and cultural features of the facade, or front, of a building.  Generally effective immediately, the Act revises the rules for qualified conservation contributions with respect to property for which such charitable deductions are allowable by reason of a property's location in a registered historic district.  Under the Act, charitable deductions are allowable only with respect to buildings, but the facade easement must preserve the entire exterior of the building, including the space above the building, the sides, the rear, and the front of the building.  In addition, the easement must provide that no portion of the exterior of the building may be changed in a manner inconsistent with the historical character of such exterior.  The Act also provides that the deduction must be reduced by a pro-rata portion of any rehabilitation credit claimed for the building.  Finally, the donor must include a qualified appraisal, photographs, a description of development restrictions, and a $500 filing fee with the tax return on which the deduction in excess of $10,000 is claimed.  (The provision relating to the filing fee is effective for contributions made 180 days after the date of enactment.)

Summary

As you can see, the Pension Act made a number of important changes, several which may have an impact on your charitable giving practices.  While the foregoing summary is intended to be an accurate account of the new law, it is not intended to be tax advice.  As such, you should consult with the text of the new law, as well as its legislative history and tax counsel, for specific guidance.  As always, we would be pleased to assist you before you act on any information contained in this letter.

For additional guidance, or if you would like to discuss how this will affect your tax planning, please contact our firm at (412) 881-4411.  If you do not have a contact at Case | Sabatini, simply ask for Jim Dee and he'll make sure to put you in touch with the CPA whose background most closely matches your needs.

www.CaseSabatini.com

Disclaimer: To ensure compliance with requirements imposed by the Internal Revenue Service, we inform you that any tax advice contained in this communication (including any attachments) was not intended or written to be used, and cannot be used, for the purpose of (i) avoiding any penalties that may be imposed, or (ii) promoting, marketing, or recommending to another party any transaction or matter addressed herein.

   
© 2006 Case | Sabatini.