Pending legislation: tax code changes will impact most charities.

For nearly two years, the Senate Finance Committee has been considering changes to the tax rules affecting nonprofit organizations. Last fall, the full Senate passed S. 2020, The Tax Relief Act of 2005, by a vote of 64-33. That bill has recently been renamed as H.R. 4297 to facilitate the conference with the House of Representatives.

This legislation contained a number of reform provisions, as well as incentives for charitable giving. Last month, this column discussed some of the reform provisions. This month's column will cover the incentive provisions. You must keep in mind that the House of Representatives passed tax relief legislation that did not contain any of these provisions. Their enactment will depend on action taken by a Conference Committee.

At the time this article was written, the Senate had just started the process of preparing for the conference, with the House to follow shortly. Consequently, as you read this, some or all of these provisions could have become law or been dropped from consideration. However, some of them will eventually become law in some form.

Incentives for individuals to make charitable gifts

The bill contains two significant incentives for individual charitable giving--a deduction for non-itemizers and non-taxable transfers of funds from IRA accounts during a donor's lifetime.

Currently, only taxpayers who itemize their deductions can receive a tax benefit for their charitable contributions. While most donors of significant amounts do itemize and receive the benefit, many donors of smaller amounts do not. Thus, the Senate believes that if there is some deduction allowed, the total amount of donations made will increase dramatically.

The Senate decided to put some strings on the deduction, however. Only cash donations (including checks and credit cards) will qualify for the deduction. You will not be allowed to deduct donations of property unless you itemize. Therefore, the Internal Revenue Service (IRS) will not have to worry about valuation issues in administering this provision. Also, to limit the deduction and control the budget impact, only donations above a set floor will qualify. If you are a single filer, your donations will have to exceed $210 before they qualify for the deduction. If you donate $500, for example, your deduction will be $290. If you file a joint tax return with your spouse, the floor is increased to $420.

These floors will also apply to deductions claimed by those who itemize their deductions. Some charitable representatives are concerned that these floors may actually discourage contributors from making donations, but the ultimate impact of these provisions will only be known after they have been in the law for some time.

The second broad incentive is to allow lifetime transfers of IRA accounts to charity without negative tax consequences. Currently, if an individual older that 59-1/2 transfers an amount to charity from an IRA, the amount is first treated as a distribution from the IRA and is included in taxable income. Secondly, the individual can deduct the amount given to the charity, so it would appear that there is no tax impact from this transaction.

Unfortunately, this is not the case. If your adjusted gross income exceeds certain limits (generally, $145,950 for 2005 returns), you have to reduce your itemized deductions by 3 percent of the amount in excess of that limit. The maximum reduction is 80 percent. Also, your deduction for personal exemptions for you and your dependents is reduced if your adjusted gross income exceeds certain limits.

Therefore, if you withdraw $100,000 from your IRA and give it to charity, you will still end up with a $3,000 increase in your taxable income in addition to the phase-out of your exemption deductions.

To reduce this anomaly, the bill provides that a lifetime withdrawal from an IRA (traditional or Roth) that is transferred directly to a charity or split-interest arrangement will not be included in income or allowed as a deduction. Thus, it will be a true wash for tax purposes. The benefit is only available for individuals who have reached the age of 59-1/2.

Other incentive provisions

The bill contains other incentive provisions that are narrowly targeted. It will expand the existing enhanced deduction programs for book and food donations, and will limit the reduction in the basis of an S corporation shareholder's stock to the basis of property given to charity.

If you give property that meets the rules of qualified conservation contributions, you will be able to deduct the fair market value up to 50 percent of your adjusted gross income, rather than 30 percent. However, the deduction is limited to the excess of 50 percent of your adjusted gross income over all other donations that qualify for that limitation. You can carry forward excess conservation contributions for 15 years instead of five.

If an individual donates property created during the 18 months prior to the donation, it can be deducted at its fair market value. This applies to literary, musical, artistic or scholarly compositions, similar property, and copyrights thereon. This deduction can only be used to offset taxable income from the donor's artistic activities, however, and not other income. Also, the donee must use the property in a manner related to its charitable purpose or function.

Does your organization reimburse volunteers for the use of their vehicles to carry out your purposes? If you do, do you pay them more than 14 cents per mile? Under the Internal Revenue Code, the deduction for use of a vehicle for charitable purposes by a volunteer is limited to the lesser amount. Any reimbursement in excess of 14 cents per mile is taxable to the volunteer. The bill would exempt these amounts from income taxation.

The last incentive is a change to the unrelated business income tax rules that apply to payments from controlled organizations. Under present law, if you receive interest, rents, annuities or royalties from an organization that you control, you may be subject to UBIT on that amount. If the controlled organization is conducting an activity that would be unrelated if you did it, and the payments are attributable to that activity, the amount you receive is taxable as unrelated business income.

This is the case regardless of whether or not the controlled organization receives a profit from the activity. The bill provides taxation only in cases where the payment exceeds the fair market value of such a payment. There will also be a 20 percent penalty on any valuation misstatements.

More reform provisions

Several reform provisions were discussed in last month's column. In addition to those items, the bill includes a number of other reforms. We will discuss some of them here.

First, if your organization engages in a prohibited tax shelter transaction (known as a reportable transaction), the bill will impose a penalty equal to the greater of 100 percent of the net income or 75 percent of the gross proceeds attributable to the activity.

The IRS can impose a fine of $20,000 on an entity manager who knowingly approves the transaction.

Most of the penalty taxes that apply to private foundations that engage in certain transactions will be doubled under the bill. These include self-dealing, minimum distributions, taxable expenditures, excess business holding and jeopardizing investments. The excise tax on self-dealing involving compensation will increase from 5 percent to 25 percent, which is the excise tax rate applied to excess benefit transactions by public charities.

The rules would tighten for contributions of facade easements on historic properties. The donee will have to agree to maintain all of the exterior walls under the easement. There are a number of other requirements, including a processing fee to the IRS of $500 if the deduction will exceed the greater of $10,000 or 3 percent of the fair market value of the property.

In 2004, Congress tightened the rules applicable to donations of vehicles to charity. This bill targets donations of clothing and household items as well. First, the charity will have to substantiate the number, type and condition of the donated items if the deduction exceeds $250.The IRS will have to prepare a list of standard fair market values by type of item, and you will have to provide it to your donors. If the items are not in good condition, the deduction will be limited to 20 percent of the IRS list value.

A donor will have to substantiate all cash donations with a cancelled check or acknowledgement from the charity. This will put severe limits on small donations to holiday fundraising activities such as kettles, workplace solicitations and other fundraisers that rely on cash.

There are other provisions in addition to those discussed in this and last month's articles. Again, these provisions have only passed the Senate and will need to be included in a conference agreement to become law. We will let you know if this occurs. In the meantime, if you have significant problems with any of these provisions, you should let someone know of your concern.

Harvey Berger, CPA, is a partner and national director of not-for-profit tax services in Vienna, Va., for the accounting and management consulting firm Grant Thornton LLP. His email address is [e-mail]. D. Greg Goller, CPA, is the partner-in-charge, Not-For-Profit Solutions Group in Grant Thornton LLP's Washington, D.C. office. His email is [e-mail].