Pension Protection Act of 2006 Brings Retirement Tax Breaks and New Restrictions on Charities
The Pension Protection Act of 2006, signed by President Bush on August 17, 2006, includes the following provisions that may be of interest to our estate planning clients:
Direct Contributions of Individual Retirement Accounts to Charity
During calendar years 2006 and 2007, a person age 70½ or older may make charitable gifts of up to $100,000 per year directly from an individual retirement account (IRA) to a qualified charity without having to include the distributions in taxable income. Since the distributions are not reportable as income, the taxpayer cannot take an income tax charitable deduction for the gift. However, the distribution will count toward the donor’s minimum distribution requirement for the year of the gift.
Note the following limitations:
- The exclusion only applies to traditional and Roth IRAs. It does not apply to any other retirement plan account.
- The exclusion only applies to lifetime transfers. It does not apply to distributions occurring upon the donor’s death.
- The distribution must pass directly from the IRA to the charity. The donor must not receive the distribution.
- The recipient organization must be a public charity or a “conduit private foundation.” Transfers to more typical private foundations, or to donor advised funds or supporting organizations, will not qualify for this exclusion.
- The donor must be age 70½ or older at the time of the gift.
- The amount distributed to the charity must not exceed $100,000 in either permitted year (2006 and 2007).
The exclusion from income can be quite beneficial to individuals who wish to make charitable contributions but do not itemize deductions. For taxpayers who do, the ability to exclude the gift from income means that the taxpayer will not face the consequences of any phase-out rules or percentage limitations that could reduce the benefit of the charitable deduction.
Rollovers of Retirement Plan Assets into IRAs Now Available to Beneficiaries Other Than Spouses
Employer sponsored retirement plans often require benefits to be paid to a “designated beneficiary” in lump sum or within five years after a participant’s death. Prior to the enactment of this legislation, only the spouse of the deceased participant was eligible to roll these retirement benefits into an IRA and continue the income tax favored status of the benefits. The new law provides that for distributions made after December 31, 2006, a nonspouse beneficiary may direct the trustee of the retirement plan to make a direct “trustee to trustee” transfer of the retirement plan assets into an IRA for the nonspouse beneficiary. The IRA will be treated as an inherited IRA, so that the benefits will be distributed in accordance with the minimum distribution rules that apply to inherited IRAs. Beneficiaries who inherit retirement plans from participants who died during 2006 should consider deferring their distributions until 2007 in order to take advantage of this planning opportunity.
New Restrictions on Charitable Contributions of Fractional Interests in Tangible Personal Property
In our Fall 2005 newsletter, we discussed a tax-savings plan whereby an individual collector could make a lifetime gift of a fractional interest in art or other tangible personal property and obtain a current income tax charitable deduction. As explained in that article, if the use of the art or other donated property is related to the charity’s exempt purpose (as in the case of a museum that will display the work), then the charitable deduction will be based upon the fair market value of the property, adjusted to reflect the donated fractional interest. If the use of the property is unrelated to the exempt purpose of the charity, then the charitable deduction will be based upon the donor’s tax basis in the property, adjusted to reflect the fractional interest given away.
It is still possible for a collector to give away a fractional interest in a piece of art, enjoy part-time possession of the art, and obtain a current income tax charitable deduction for the fair market value of the fractional interest given away. However, such gifts made after the effective date of this new legislation will be subject to additional restrictions, which are summarized as follows:
A recapture of the income or gift tax charitable deduction will occur if the donor does not contribute all of the donor’s remaining interests in the property to the charity within 10 years of the initial contribution (or earlier death), and where the charitable organization does not have substantial physical possession of the property and has not used the property for the charity’s exempt purpose. This means that the taxpayer will have to recapture the deduction and pay a penalty tax equal to 10% of the recaptured amount.
- If the charitable deduction is based upon fair market value, then the value of the gift for purposes of determining the income tax charitable deduction for any future donations of fractional interests in the same property will be limited to the lesser of the value of the property at the time of the initial gift and the value of the property at the time of the subsequent gift (if the value decreased), adjusted to reflect the fractional interest.
- It is important to note that the gift of the remaining interest to the charity at the donor’s death could actually generate estate tax. This could occur because the value of the charitable deduction for estate tax purposes will be limited to the value of the property as of the initial gift. If the actual value of the artwork increased between the date of the gift and the date of the artwork’s inclusion in the taxable estate of the donor, the limited estate tax charitable deduction would not be sufficient to offset the value of the testamentary gift reported on the estate tax return, and estate tax could be generated.
- All owners of the art or item must make a proportionate contribution to the charity. For example, if a work of art is owned by two individuals equally, then each must make a contribution of the same fractional interest to the charity.
Other Notable Provisions of the Act.
- Section 529 Plans have been made permanent. However, regulations are to be established which aim to prevent certain abuses in the use of these plans (such as in the case of an individual who takes advantage of the five-year contribution rules and establishes plans for several beneficiaries, with the intention of later changing these to benefit only one beneficiary).
- Contribution limitations to 401(k) plans and IRA accounts which were set to expire under the 2001 legislation have been made permanent.
- Donations of tangible personal property to charity are deductible at fair market value only if the property is used to further the exempt purpose of the charity. Under the new rules, if a charitable organization sells such tangible personal property within three years of the donation, the taxpayer’s deduction will be reduced from fair market value to the taxpayer’s basis in the property, resulting in a recapture of the tax benefit, unless the charity certifies to the IRS that the property was used for the charity’s exempt purpose, but that continued use of the property became impossible or unfeasible to implement.
- There are a number of new operating restrictions that now apply to donor advised funds.
- The requirements for gifts to supporting organizations are more strict.