Tax free distributions from IRAs

Sec 408 of the Internal Revenue Code (IRC) was amended to provide that taxpayers who have reached age 70 ½ can make a distribution directly from their IRA to a charity without having to include the amount of the distribution into taxable income.  Individuals can donate up to $100,000 per year (from either their traditional or Roth IRA) for both 2006 and 2007 without being taxed on the income.  Consequently, the individuals will not be entitled to a charitable deduction for these amounts; however, the distribution will count towards the minimum distribution requirements.  This treatment won’t be as beneficial if the distribution is made from a Roth IRA since distributions from a Roth IRA are not taxable, but it will help if the individual needs to meet minimum distribution requirements for the year.

The distributions must be made directly to a qualifying charitable organization from the IRA.  Qualifying organizations are defined as fifty-percent organizations and include educational institutions, hospitals, governmental units, and other publicly supported organizations. Contributions to supporting organizations and donor-advised funds are not qualifying distributions so care must be taken when contributing to foundations of educational institutions, hospitals, etc as these tend to be supporting organizations.

Charitable Contributions of Clothing & Household Goods

Under the new law a deduction for the charitable contribution of clothing or household goods will only be allowed if the item is in good used condition or better.  The IRS, by regulation, has the power to deny a deduction for a contribution of clothing or household items that have minimal monetary value.  These minimal value provisions do not apply if the deduction for a single item of clothing or household item is more than $500 or if a qualified appraisal is included.  These provisions became effective the date of enactment so all donations of clothing and household items after August 18, 2006 are subject to these new rules.  The IRS is working to issue regulations in this area, but it is not clear when these regulations may be issued or how the IRS is going to monitor the donations.

The recordkeeping rules for substantiating charitable contributions have also changed.  The old rules required substantiation (documentation) for any contribution of $250 or more. But under the new rules, a donor no longer can give a cash donation and take a deduction without having some type of receipt. Documentation by a bank record (cancelled check or other record) or a receipt, letter, or other written communication from the donee organization must be maintained for every contribution no matter the amount. Information that should be included on the documentation includes the name of the donee organization, date of contribution, and amount of contribution. These rules are effective for tax years beginning after August 17, 2006.

Donations of real property for conservation purposes encouraged

To encourage donations of conservation property, the law now allows the donor to take a deduction up to 50% of his contribution base (generally 50% of adjusted gross income) for a qualified conservation contribution instead of being limited to 20% or 30%. Any excess may be carried forward 15 years. A qualified conservation contribution is a contribution of a qualified real property interest to a qualified organization to be used exclusively for conservation purposes. The contribution may be the entire interest in the property or it may be a partial interest or easement.  Preservation of land areas for outdoor recreation, protection of a natural habitat, preservation of open space, or the preservation of an historic structure would generally be included. For qualified framers or ranchers who donate property that remains available (but no necessarily used) for agriculture or livestock production, the deduction limit is raised to 100% of adjusted gross income. These provisions are effective for tax years beginning after December 31, 2005 but ending by December 2007 (calendar years 2006 and 2007).

Contributions of Book and Food Inventory

The act extended the enhanced deduction for corporate donations of book inventory to public schools (k-12) for another two years.  This provision (originally enacted in response to Hurricane Relief) is now set to expire for contributions made after December 31, 2007. Any qualifying book contributions made between August 28, 2005 and December 31, 2007 will qualify for the enhanced deduction.  Corporations (other than S corporations) who make qualifying donations will be able to deduct the lesser of (1) the donated inventory’s basis plus ½ of the item’s appreciation or (2) two times donated inventory item’s basis.

Similarly, the act extended the enhanced deduction for noncorporate donations of food inventory.  The taxpayer must be engaged in a trade or business and the deduction is limited to 10% of the income from the business making the donation.  The deduction amount is calculated similar to that of the book inventory.  In both cases, the items must be usable by the donee organizations to qualify for the enhanced deductions.

Donor Advised Funds

Many of the charitable related provisions in the PPA were aimed at Donor Advised Funds and Supporting organizations. The IRS and Congress see these two areas where many abuses can and do occur. The new law disallows a charitable deduction for income tax purposes for contributions to donor advised funds that are maintained at noncharitable and Type III supporting organizations. Generally, if the donor advised fund’s sponsoring organization is a war veteran’s organization, lodge or Cemetery Corporation or a supporting organization that is not a functionally integrated Type III supporting organizations, then the deduction is disallowed.  Deductions for gift and estate tax purposes are also disallowed. 

Contributions to other donor advised funds will generally be allowed only if the taxpayer has written acknowledgement that the fund controls the assets versus the donor having control.  This acknowledgement must provide that the sponsoring organization has exclusive legal control over all assets contributed to the fund.  These new rules are effective for contributions made after February 15, 2007 (180 days after the date of enactment). 

Several provisions of the act affect how sponsoring organizations (defined in IRC 4966) are treated and require certain disclosures to be made.  Sponsoring organizations are organizations that maintain one or more donor advised funds.  The new provisions require that for any new exemption applications, an organization requesting to be a sponsoring organization must note whether maintains or plans to maintain donor advised funds and the manner in which the organization plans to operate the funds.  For annual reporting on the Form 990, the sponsoring organization must list the total number of donor advised funds it owns at the end of the year, disclose the aggregate value of assets held by the donor advised funds at the end of the year, and disclose the aggregate contributions made to and grants made from the funds during the year.  The provisions for annual filing are effective for tax years ending after the date of enactment and for all exemption applications filed after the date of enactment

Supporting Organizations

Supporting organizations (like Donor Advised Funds) are also subject to additional reporting requirements under the new act.  A supporting organization is a type of public charity whose exempt purpose is to support one or more other exempt organizations. The three types of supporting organizations are: Type I – organizations that are “operated, supervised, or controlled by” the supported organization, Type II – organizations that are “supervised or controlled in connection with” the supported organization, and Type III – organizations that are “operated in connection with” the supported organizations.

The new law requires all supporting organizations to file an annual information return (Form 990) regardless of the organization’s gross receipts.  On the return, the supporting organization must list the organization or organizations that it supports, whether it is a Type I, Type II, or Type III supporting organization, and certify that it is not controlled by disqualified persons.  The type of supporting organization can generally be found in the organizations tax-exempt determination letter. These provisions are effective for tax years ending after August 18, 2006 so they would apply to all calendar year 2006 returns as well as returns with fiscal years ending in August – December 2006.

Treasury has also commissioned a study of Donor Advised Funds and supporting organizations to look at how donations are used, to see if minimum distribution requirements should be implemented, and to see whether retention of some rights and privileges by donors with respect to donated amounts is consistent with the treatment as complete gifts.

Excise Taxes

The new law has expanded certain excise taxes to apply to Donor Advised Funds and Supporting Organizations. First, Donor advised funds are now subject to a 20% excise tax on distributions to an individual or to an organization if the distribution is not for charitable purposes. Fund management is also subject to a 5% excise tax for approving the distribution. The law expanded the definition of disqualified person under the Intermediate Sanctions Rules (IRC Section 4958) to include donors, donor advisors, and investment advisors of Donor Advised Funds. Lastly, the new law makes the excess business holdings rules that previously applied only to Private Foundations, also apply to Donor Advised Funds and Type III Supporting Organizations.

In addition to applying these excise taxes to Donor Advised Funds and Supporting Organizations, PPA doubled the excise taxes for Intermediate Sanctions, self-dealing and taxable expenditures as well as increased the maximum penalty on organization managers from $10,000 to $20,000. The PPA also increased the tax base for the 2% excise tax on the net investment income of Private Foundations. The new broader definition of net investment income most likely includes income from annuities, notional principal contracts, and other substantially similar income from ordinary and routine investments. Also, gain or loss on the sale of property is included if the property was used for the production of gross investment income. 

Notification requirements for entities not currently required to file returns

Tax exempt organizations that have previously not had to file an annual return with the IRS because their gross receipts were less than $25,000 will have to file an annual notification with the IRS. This annual notification must include the organization’s legal name, any name under which it does business, mailing address, web site address, EIN, name and address of principal officer, and evidence of the continuing basis for its exempt purpose. The IRS will proscribe regulations citing the manner and specifics to be included in the annual notification. The notice is to be sent in electronic form.  While no monetary penalties are currently associated with this notice, failure to file the notice can result in the loss of tax-exempt status for the organization.  This notice will also be subject to the public inspection and disclosure statutes.  These provisions apply to annual periods beginning after 2006.

Disclosure of UBTI Returns

The new rules require that all 501(c)(3) organizations make their unrelated business income tax returns (Form 990-T) available for public inspection. The requirements are the same as the current disclosure requirements for Form 990s and Form 1023s. These requirements are effective for all returns filed after the date of enactment.

Changes to IRC Section 512(b)(13)

After a nine year wait, anticipated changes to IRC Section 512(b)(13) were finally made into law.  Section 512(b)(13) governs the treatment of certain types of payments made by a taxable entity (corporation, partnership, etc) to a tax-exempt organization that controls it.  Before the changes made by the PPA, any amount paid for interest, rent, and royalties was taxable to the controlling exempt organization.  The new law makes only the excess over Fair Market Value taxable, so as long as the transaction is treated as arm’s length and done at Fair market value, no tax will be due. 

The provisions only effect payments received in 2006 and 2007 unless Congress makes the change permanent. In addition, the controlling exempt organization must report all payments and transfers of funds received from a controlled taxable entity including interest, rents, royalties, annuities, and loans. 

Disclosures to State Taxing Authorities

The new rules give the IRS the authority to disclose certain proposed actions to the state taxing authorities.  Such actions include (1) proposed refusal to recognize such organizations as Sec. 501(c)(3) organizations, (2) proposed revocation of exempt status, or (3) information on returns regarding charitable fundraising or solicitation of charitable funds. Disclosures can be made to state officials including the State Attorney General, tax officer or the state official in charge of overseeing Sec. 501(c)(3) organizations.