Saving Tax Dollars: The Gifts That Keep On Giving

By Patricia Bell Harik, C.P.A., M.S.T.

Vice President, Zdonek & Wolowicz Accountancy Corporation

Charitable Giving Provisions for Individuals
The Pension Protection Act of 2006
A long time ago, our government figured out that charitable giving not only benefits many aspects of American life, but also eases the burden of caring for the tired, hungry and poor. In the never-ending pursuit to fine-tune our tax rules in this area, the government passed the Pension Protection Act of 2006. The Act contains important provisions designed to encourage charitable contributions by individuals. These provisions have been contemplated for several years now; the pension bill not only expands the charitable contribution deduction, but attempts to curtail perceived abuses. The Pension Act contains a number of restrictions on the ability to obtain a deduction for donations of certain kinds of property. However, with proper planning, taxpayers can still take advantage of the new deduction opportunities while maximizing the tax benefits of any gifts that are subject to the new restrictions.

Below is a 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
In our practice where we service many retired, high net-worth individuals, this particular provision has been very well-received. 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. Because the deduction is limited to 50 percent of the IRA owner's adjusted gross income, the owner often does not get a full deduction in the year of the gift.

These impediments disappear 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 your tax advisor immediately if you would like to make such a gift and will be at least age 70 during 2006 or 2007 to obtain the maximum tax benefit.

Increased Deduction for Conservation Contributions
Taxpayers may take 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 can 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 percent 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 percent 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 percent 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 another 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.

Cut-Back on Deductions for Gifts of Tangible Personal Property
Under prior law, a donor of a gift of tangible personal property (i.e., other than cash, securities, or intellectual property) 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. The Pension Act extends this restriction 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.

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 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 Act, any gift of money (by cash or check) may be deducted only if supported by a bank record or a written acknowledgement from the donee organization. This provision is effective for taxable years beginning after August 17, 2006, and may discourage small cash gifts.

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 percent 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 half 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 full ownership.
The Pension Act imposes significant limitations on this type of planning. Although a donor may still make fractional gifts, those have become subject to the following restrictions: (1) the donor must own 100 percent 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 percent 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 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 Type III supporting organization and (3) the sponsoring organization provides the donor with a written acknowledgement of the gift that explains that the former 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 Penalties for Valuation Misstatements
Congress also used the Pension Act as an opportunity to re-examine the penalties imposed on taxpayer overstatements of the value of gifted property. The Act reduces the threshold for imposition of the 20 and 40 percent tax penalties on valuation misstatements for charitable contribution purposes. The penalties kick in when a taxpayer significantly overstates the value of contributed property. Formerly, the 20 percent penalty was imposed when the overstatement of value was 200 percent or greater, but that threshold is now reduced to 150 percent. Before the Pension Act, the 40 percent penalty was imposed when the overstatement was 400 percent or greater; that threshold is reduced to percent. In addition, a new penalty is imposed on any appraiser who is responsible for the overstatement.

Limits on Contributions of Taxidermy
Another subject of recent Congressional hearings was overstated deductions claimed for charitable gifts of big game mounts and other types of taxidermy. As a result, 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.

As you can see, the Pension Act made a number of important changes, several of which may have an impact on your charitable giving practices. As always, please consult your tax advisor before acting on any of these new provisions to avoid those traps for the unwary.

Source: The Bureau of National Affairs, Inc., Washington D.C.