Katrina Emergency Tax Relief Act
Frequently Asked Questions *
What is the new 2005 End of Year Gift concept?
Congress wanted to help charities assisting with Hurricane Katrina relief. Therefore, the Katrina Emergency Tax Relief Act (KETRA) allows unlimited gifts to charity up to a donor's total income until the end of 2005. Under Section 301(b)(1)(A), a "qualified contribution shall be allowed only to the extent that the aggregate of such contributions does not exceed the excess of the taxpayer's contribution base (as defined in subparagraph (F) of section 170(b)(1) of such Code) over the amount of all other charitable contributions allowed under such section 170(b)(1)." Therefore, a donor may usually make gifts up to 100% of adjusted gross income (AGI).
When is this 100% gift deduction rule applicable?
Qualifying cash gifts must be made between August 28, 2005 and December 31, 2005.
Which charities qualify for the 100% deduction?
Public charities generally will qualify.
Must the 2005 End of Year Gift be for Katrina relief?
No, if the gift is by an individual, but yes if it is by a corporation. A corporation may give up to 100% of taxable income for Katrina relief. An individual may make a 2005 end of year gift to public charities for any purpose.
Which charities or gifts will not qualify?
With the new 100% gifts rule, there are several exceptions -- no private foundation gifts, no supporting organization gifts, no donor advised fund gifts and no gifts of property such as stock or land. Section 301(d)(2) creates an exception that states that a qualified gift "shall not include a contribution if the contribution is for establishment of a new, or maintenance in an existing, segregated fund or account with respect to which the donor (or any person appointed or designated by such donor) has, or reasonably expects to have, advisory privileges with respect to distributions or investments by reason of the donor's status as a donor."
How does this affect potential IRA Withdrawal-gifts?
When a person over age 59½ withdraws funds from his or her IRA, the withdrawal will be included in the IRA owner's taxable income. Under the new 100% of income charitable gifts option, the withdrawn funds may be given in full to charity. The full gift will then be deductible. In addition, since the 100% deduction applies regardless of the gift source, withdrawals and gifts may also be made from 401(k) plans, 403(b) plans or other qualified retirement plans.
Is the 2005 End of Year Gift different from the IRA Tax-Free Rollover?
Yes. During the negotiations between the House and Senate, the decision was made to delete the IRA Tax-Free Rollover from the Katrina Relief bill. The IRA Tax-Free Rollover did not pass. However, the 2005 cash gifts provision was then added to the Katrina Relief bill.
Is there a dollar limit to an IRA Withdrawal-gift?
Good news -- the IRA withdrawal and gift option is unlimited. A person can withdraw and give $1,000 or $1,000,000. The gift is limited only by the donor's AGI. Of course, by withdrawing funds from an IRA, the donor's AGI increases. However, the entire withdrawal may be gifted to charity and deducted with no Section 68 application (the 3% reduction in itemized gifts over $145,950 of AGI for 2005). While the Section 68 limitation will not apply to end-of-2005 charitable gifts, it will still apply to other deductions. Therefore, the increased AGI may affect other deductions.
How should a donor make an IRA Withdrawal-gift?
The IRA owner should withdraw the desired amount this year and make the gift by December 31, 2005. Warning -- some IRA custodians take two to three weeks to process withdrawal requests! IRA owners should make the withdrawal request by early December to allow time for processing by the IRA custodian. Donors must have the cash available and complete the cash charitable gift by December 31st to qualify.
With a large IRA withdrawal and then gift, will the donor receive a full deduction?
Yes, the withdrawal increases taxable income, and the gift reduces taxable income.
Are other income tax limits affected by IRA Withdrawal-gifts?
Usually, for higher income taxpayers, approximately 3% of itemized deductions are not allowed. For cash gifts to charity between August 28th and December 31st of 2005, the 3% reduction does not apply to the charitable gift. 100% of the charitable gift is deductible. Section 301(c) creates an exception for qualified charitable gifts and notes, "So much of any deduction allowed under section 170 of such Code as does not exceed the qualified contributions paid during the taxable year shall not be treated as an itemized deduction for purposes of section 68 of such Code." It appears that the IRS will treat these cash charitable deductions as itemized deductions not subject to the 3% rule.
The probable cost of the 3% rule for donors with adjusted gross income over $145,950 is a loss of three percent of itemized deductions over that limit. For most donors who are not affected by the higher floors for medical deductions or casualty losses, the actual federal tax cost would be 1% of the IRA withdrawal-gift. The donor and his or her CPA would need to consider this cost in deciding whether or not to make a major IRA withdrawal-gift this year. For some donors with strong charitable intent and a large IRA, this 1% cost may be acceptable. For others, this may not be an acceptable cost.
Will state income taxes be a factor?
There are four categories of state income taxes. First, several states (Florida, Texas, Nevada, Washington, and others) do not have state income tax. Second, some states conform to the federal deduction rules. If the state starts with the federal taxable income and then makes adjustments, it is possible that there is no adjustment for the larger limit this year and the full 100% deduction may be permitted. Third, some states follow the federal 50% AGI deduction limit with a five year carry-forward. Fourth, some states have less favorable rules for charitable deductions. IRA withdrawal-gift plans will generally be considered only by donors in state categories one and two, since there is no increase in state income taxes. However, CPAs in all states should consider the state income tax effect of any gift over 50% of AGI.
Will there be other income tax effects?
There may be for some donors. When adjusted gross income is increased, deductions such as medical deductions or casualty deductions with "floors" to the deductible amount may be affected. It also appears that there will be no alternative minimum tax (AMT) impact on taxpayers who make cash gifts in 2005. If a donor is subject to AMT, the cash gift saves tax at the AMT rate, which may be lower than taxpayer's regular tax rate.
Will there be a tax-free rollover option for IRA gifts in 2006?
There may be a tax-free IRA rollover option by the year 2006. The CARE Act of 2005 was introduced in both the House and Senate on September 28, 2005. The Senate bill (S.1780) was introduced by Sen. Rick Santorum (R-PA) and Sen. Joe Lieberman (D-CT). Co-sponsors include Senators Bill Frist (R-TN), Orrin Hatch (R-UT), Dick Lugar (R-IN), Daniel Inouye (D-HI), Jim Bunning (R-KY), Norm Coleman (R-MN), and Gordon Smith (R-OR). In the House, Acting Leader Roy Blunt (R-MO) and Rep. Harold Ford Jr., (D-TN) introduced the Charitable Giving Act (H.R.3908).
The CARE 2005 Act permits tax-free gifts directly from IRAs to charity for persons over age 70½. Tax-free rollovers to gift annuities and charitable remainder trusts are allowed for IRA owners over age 59½ (Senate) or over age 70½ (House).
The CARE Act passed both the House and Senate in 2003, but did not go to conference. With the enormous need for relief services after Hurricanes Katrina and Rita, there is new energy in the effort to pass charitable legislation. It is especially significant that the majority leaders in both the House and Senate (Rep. Blunt and Sen. Frist) are publicly supporting the CARE Act of 2005. Since Congress will be in session until December due to Katrina Relief legislation, Sen. Frist and Rep. Blunt have the power to schedule floor votes on the CARE Act during 2005.
With the possibility of passage of the CARE Act, donors contemplating large gifts with a 1% tax cost should wait until December. By that time, prospects for passage of the CARE Act will have greater clarity. If there is no action on the CARE Act by December, then these donors and their advisors will need to consider the possibility of making a large gift in 2005, even with some tax cost. If passage of the CARE Act seems likely, then some donors may decide to wait until 2006 to make IRA charitable gifts.
Could you share several IRA Withdrawal-gift examples?
Teacher - John IRA Owner is a retired teacher living in Nevada. He has income this year of $40,000 and also has other income from municipal bonds. John makes gifts each year to his favorite charity. With $40,000 of income, he normally gives and deducts up to one-half of his income, or a maximum of $20,000 per year. He is age 74 and has an IRA of $950,000. John wants to make a major gift this year to favorite charity. He withdraws $50,000 from his IRA, and his income is now $90,000. John gives the $50,000 to favorite charity by December 31, 2005 and deducts the $50,000. His income for tax purposes is reduced to the original $40,000.
Surviving Spouse - Helen Wilson is a 75 year-old surviving spouse from Florida with an income of $55,000. When her husband Harry was alive, they talked about making a gift to favorite charity for the Wilson Fund (not a donor advised fund). Due to Harry's sudden illness and death, they had not created the Wilson Fund prior to his demise. When Harry passed away, Helen was the primary designated beneficiary on his $600,000 IRA. She rolled over his IRA and combined it with her IRA. Helen now has a home, securities and CDs of $350,000 and the combined IRAs of $960,000. Harry and Helen had talked about taking $90,000 and making the gift for the Wilson Fund. Since Helen wants to keep her $350,000 in securities and CDs, she had not made the gift. Fortunately, with the 2005 End of Year Gifts option, there is a wonderful solution. Helen can withdraw $90,000 from the IRA and give this amount to favorite charity for the Wilson Fund. Her income will increase to $145,000, but she receives a deduction of $90,000 to lower her taxable income back to $55,000. Best of all, her non-IRA assets are protected. Since her IRA still will have a balance of $870,000, she is pleased. Helen achieved their charitable goal with a deductible gift that helps keep her IRA and non-IRA assets in balance.
Business Owner - Mary IRA Owner is a Texan with adjusted gross income this year of $200,000 and taxable income of $160,000. During her years in business she built up a large IRA. When she retired three years ago, she sold the business and rolled her qualified retirement plan over into an IRA. She has an IRA of $4,000,000 and wants to help her favorite charity with a large gift. In December of 2005, Mary withdraws $1,000,000 from her IRA, increasing her adjusted gross income to $1,200,000. She gives $1,000,000 to charity by Dec. 31, 2005 and deducts the $1,000,000. Her income for tax purposes is reduced from $1,200,000 by the charitable gift and other deductions to approximately $190,000. Therefore, her income tax increases by about $10,000 or 1% of her IRA-withdrawal and gift. This increase is due to the higher AGI. Mary decided that this cost was an acceptable part of her efforts to fund a major project now, rather than waiting to fund the project through her estate.
Editor's Note - Some income and deduction figures are simplified for illustration purposes. Donors should obtain precise projections from their CPA using updated 2005 software.
* Taken from Crescendo Interactive, Inc.
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