Pension Protection Act: new federal rules will impact your organization and donors.

The Pension Protection Act of 2006 (Act) signed by President George W. Bush this past August contains numerous provisions relating to the private pension system. It also contains incentive and reform provisions that affect donations to and operations of nonprofits. The provisions are the culmination of a process that began in 2004 when the Senate Finance Committee issued a discussion draft of possible changes.

This column highlights some of the nonprofit reforms and incentives. Subsequent columns will discuss retirement plan changes that might affect your organization, as well as a detailed analysis of new provisions affecting donor advised funds and supporting organizations.

Giving incentives

Tax-free IRA transfers. The change with the most revenue potential for nonprofits is the allowance of tax-free transfers from Individual Retirement Accounts (IRA) to charitable organizations. This proposal has been around for a while and was highly desired by the nonprofit community.

Prior to the Act, individuals could make unlimited charitable bequests of IRAs at their death. These bequests were not subject to estate taxes and were tax free to the receiving charity. Lifetime transfers to charity were more problematic, however. Because of a number of complexities in the taxation of individuals, lifetime transfers from IRAs to charity would commonly result in some tax liability to the donor. Therefore, it was uncommon for these transfers to occur.

Now, under the Act, an individual who has attained age 70 1/2 can transfer funds directly from an IRA to a charity without tax consequences to either party.

The donor will not include the IRA withdrawal in taxable income, and will not receive a charitable contribution deduction. Thus, the transaction will be a complete wash. If you receive such a gift, you will not have tax consequences, either.

Only public charities are eligible to receive the transfers. Private foundations and supporting organizations are not eligible, and the transfer cannot be made to a donor advised fund sponsored by a public charity. Because the transfer must satisfy all of the other rules for deductible contributions, a donor cannot transfer an IRA to a foreign organization.

There are a number of special rules that deal with split-interest arrangements (charitable remainder trusts, etc.) and for computing the impact a charitable transfer will have on the donor's required distributions. If you are going to encourage these donations to your organization, you must obtain an understanding of all of these rules. While you shouldn't give tax ad vice to potential donors, they will certainly look to you for some information. Due to budgetary constraints, the Act limits this provision to distributions in 2006 and 2007.

Payments from controlled organizations. Before the Act, you were subject to unrelated business income tax (UBIT) if your organization received a payment of interest, rent or royalties from an organization that you control. It didn't matter if the payer was taxable or exempt, or whether or not it was profitable. It also didn't matter if the payment was above, at or below fair market value.

The Act changes this rule in limited situations for payments received or accrued after December 31, 2005 and before January 1, 2008. If the payment to your organization is pursuant to a binding written contract in effect on August 17, 2006, you are only taxable if the payment exceeds fair market value. If the payment is at or below fair market value, you will not owe UBIT on it. If it does exceed fair market value, you will also owe a 20-percent penalty on the excess amount. You will have to disclose any payments qualifying for the new treatment on your Form 990.

The Act extends provisions enacted in the Katrina Emergency Relief Act of 2005 that encourage donations of books and "apparently wholesome food" to charities. Corporate donors can claim an enhanced deduction for donations of these items made during 2006 and 2007.

Donors will be able to claim greater deductions for gifts of real property for conservation purposes. Such donations can be deducted up to an amount equal to 50 percent of the donor's adjusted gross income, rather than 30 percent. There is also a 15-year carryover of excess contributions. There are even more generous limits for contributions by farmers and ranchers. If you solicit these donations, you should be encouraging donors very soon, because the provision only applies in 2006 and 2007.

Charitable reforms

The Act contains 18 reform provisions, most of which were included in previous legislative proposals. Here are the items with the greatest reach.

New rules for contributions. In 2005, Congress changed the rules for donations of automobiles to attempt to rein in what lawmakers believed to be rampant overvaluations. The Act applies limitations to donations of clothing and household items.

The new rules allow deductions only for items in good used condition. It empowers the U.S. Department of the Treasury to issue regulations to deny a deduction for items that have minimal monetary value. According to the Committee Explanation of the Act, these may include "used socks and used undergarments." Donors can obtain appraisals for any single item worth in excess of $500, but they will have to do so before making the donation. The Act does not place an overall limit on deductions for donations of clothing and household items, as prior proposals did. The provision is effective for donations after August 17, 2006.

While this new provision will not change the documentation roles that apply to your organization, you will have to understand the new rules, and possibly change some of your solicitation materials. Donors might put pressure on you to indicate the condition of their used items, and you should resist this. Your only requirement is to describe the property received in general terms and indicate that you did not provide any goods or services in exchange for the donation, if that is in fact the case.

Another provision that could impact you if you receive a lot of cash donations is a new requirement that donors obtain a receipt or bank record for any contribution, regardless of the amount. This provision, which applies to donors' tax years beginning after August 17, 2006, could make it more difficult for you to raise funds through curbside appeals or other procedures to collect cash.

Public disclosure of Form 990-T. If you file a UBIT realm on Form 990-T after August 17, 2006, you will have to make it public in the same manner as your Form 990. It's presumed that these realms will also be released to GuideStar and other databases of non-profit organization returns.

Notification and non-filers. The Act mandates revocation of your exempt status if you fail to file Form 990 for three consecutive years. You will be able to file a new request for recognition of your status once you cure the delinquency. Depending on the procedures the IRS adopts to deal with these situations, this may prove to be a very burdensome requirement.

In addition, if you or related organizations do not file a Form 990 because your annual gross receipts are less than $25,000,you will have to comply with a new annual notification requirement. Each year you will have to electronically file a notification providing your legal name, other business name, mailing and Web addresses, taxpayer identification number, name and address of a principal officer and evidence that gross receipts were below the threshold. Failure to file this notification for three years will also cause revocation of your exempt status.

Doubling of penalties

The Act doubles the penalties for managers of your organizations who knowingly approve excess benefit transactions with your insiders. The penalty has been $10,000 and will increase to $20,000 in taxable years beginning after August 17, 2006. Also, most private foundation excise taxes will double under the Act.

The Act contains a number of additional provisions that could affect your organization. In addition, it is not clear that this is the last we will hear from Congress on these matters. You need to familiarize yourself with all of the new provisions and be vigilant for future changes. It is a relief that some of these changes were finally enacted, as they been discussed and speculated about for quite a while. You should consider what changes you will have to make to remain in full compliance with the tax rules that govern your organization.

Greg Goller is Grant Thornton's National Partner-in-Charge of Not-for-Profit Tax Services and is based in the Washington, D. C. area office. His email is [e-mail]. Nancy Murphy is a tax principal in Grant Thornton's Washington, D.C., Not-for-Profit tax practice. Her email is [e-mail]. Dan Romano is an executive director in the not-for-profit tax practice in Grant Thornton's New York City offices. His email is [e-mail]