On September 23, 2005, President Bush signed into law the Katrina Emergency Tax Relief Act of 2005 (“KETRA”). The new law provides some relief for taxpayers impacted by Hurricane Katrina, and it also encourages charitable giving by individuals and businesses. In the upper Midwest, most of our clients and friends thankfully do not fall into the category of taxpayers who need relief from Katrina, but they may be able to benefit from changes that are meant to encourage charitable giving.
Individual Taxpayers - Contribution Base Limitations Suspended. Under current law, deductions for cash contributions by individuals to public charities are generally limited so they do not exceed 50% of a taxpayer's contribution base, which for most taxpayers is equal to their adjusted gross income (AGI). There are also limitations on non-cash contributions. KETRA temporarily suspends the contribution base limitations for cash contributions that are treated as "qualifying contributions". Also, itemized deductions are limited for taxpayers with AGI in excess of $145,950 (married filing jointly for 2005), but KETRA also exempts qualifying contributions from these overall limitations on itemized deductions.
In order to receive the special KETRA income tax treatment, taxpayer donations must be "qualifying contributions". In order to be classified as a "qualifying contribution", the contribution must be: 1) made in cash; 2) to a public charity; and 3) must be made in a limited time window beginning August 28, 2005 and ending December 31, 2005.
Two important items to note regarding qualifying charitable contributions. First, they do not have to be made to Hurricane Katrina related relief activities. It can be speculated that Congress allowed contributions to all public charities to be treated as qualifying contributions to stimulate donations to non-Katrina charities that might otherwise be adversely impacted if donors diverted their charitable contributions for the year to Katrina related relief. Second, donations cannot go to organizations over which donors exercise control over investments or distributions, so qualifying donations cannot go to donor advised funds or private foundations.
Example: Taxpayer's AGI (or his contribution base) for 2005 is $80,000. In 2005, he makes $70,000 of qualified disaster contributions and $60,000 of other "nonqualifying" contributions to public charities. Under prior law, taxpayer's contributions would be limited to $40,000 (50% of his contribution base). But, under KETRA, taxpayer may deduct $80,000 for 2005 (total deductions cannot exceed AGI), determined as follows: Taxpayer first determines the amount of non-qualifying contributions that are deductible. The calculation is the same as prior law or limited to 50% of his AGI. Therefore, $40,000 of the $60,000 "other" contributions are deductible. Taxpayer then must determine how much of the qualifying contributions are deductible, and since the AGI limitations are suspended for qualifying contributions, the taxpayer can deduct an additional $40,000 ($80,000 total contribution base less $40,000 of contribution base used for "other" contributions). Taxpayer is left with a $50,000 carryover ($30,000 from his unused qualified contributions and $20,000 from his unused regular contributions) for use in the next 5 years, subject to the 50% limit.
Corporate Taxpayers - Contribution Base Limitations Suspended. Charitable contributions are not deductible by a corporation if they exceed 10% of a corporation's taxable income (without regard to net operating loss or capital loss carrybacks). KETRA temporarily increases the limits on a corporation's cash contributions made between August 28, 2005, and December 31, 2005, but only if the contributions are made for Hurricane Katrina relief. The suspension of limitations allows a corporation to deduct qualified contributions up to its entire taxable income (less other contributions).
Example: For 2005, Taxpayer Inc.'s taxable income is $100,000, and it makes $100,000 of qualified contributions to the Bush/Clinton Katrina Fund and $20,000 of other charitable contributions. Prior to KETRA, Taxpayer Inc.'s deduction would be limited to $10,000 (10% of $100,000). As a result of KETRA, Taxpayer Inc. is allowed a deduction of $100,000 for 2005 ($10,000 of other contributions and $90,000 of qualified contributions). Taxpayer Inc. has a $20,000 carryover ($10,000 of other, $10,000 of qualified) for use in the next 5 years, subject to the 10% limit.
Additional Provisions. There are additional provisions in KETRA for individuals related to personal exemptions for housing displaced persons, and enhanced donations for corporations of food inventories and books. If you believe these provisions may be applicable to you or your business, please contact your Michael Best advisor for further details.
CARE Act and Charitable Giving Act
Two companion bills meant to increase charitable giving, the CARE Act in the Senate and the Charitable Giving Act in the House, have been languishing in committee, even though both acts passed in their respective chambers with wide bi-partisan support. Both acts were reintroduced in both chambers on September 28, 2005, again with wide bi-partisan support. Sponsors of the bills noted that the focus of the legislation is to attempt to sustain high levels of charitable giving after donations in response to Hurricane Katrina subside, and to attempt to avoid a drop off in contributions that occurred after contributions to charity rose following the September 11 attacks.
There are two major provisions in both acts that should be of particular interest. The first provision would allow a partial deduction for charitable contributions for taxpayers who do not itemize their deductions, which accounts for two-thirds of all filers. Under present law, non-itemizers do not receive a tax benefit for charitable contributions.
The second provision would allow taxpayers to "roll over" an individual retirement account (IRA) to charity in a tax favorable way. Presently, if a taxpayer wants to contribute their IRA to a charity, they must first withdraw the monies from the IRA, recognize the income in the year withdrawn, and then receive a charitable contribution for amounts then given to the charity. As a result of the contribution base limitations discussed above, taxpayers may not be able to offset 100% of the income recognized on withdrawal by the charitable deductions. The provisions in both bills would eliminate this potential gap and allow tax-free contributions of IRA's directly to charities.
For more information please contact Bradley J. Kalscheur at 414.225.2763 or firstname.lastname@example.org.