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Recent Tax Law Changes

October 23, 2006

Effective August 17, 2006, the federal Pension Protection Act of 2006 (the act) includes significant changes to laws affecting tax-exempt organizations. The following is a brief highlight of some of the law changes and is not intended as legal advice. Should you require further information for your specific circumstances, please contact a member of either the Tax or Nonprofit Law Team.

IRA Distributions to Charities
Under the act, taxpayers who are 70 1/2 years and older can distribute up to $100,000 a year directly from both their traditional and Roth Individual Retirement Accounts (IRAs) to certain charitable organizations without recognizing any income. Usually an individual who receives a distribution from his or her IRA recognizes income that is taxable. Under this new provision, qualified taxpayers may make a distribution directly to a qualified charitable organization without recognizing any income, provided the individual receives no benefit in return and there are no substantiation issues. Such charitable distributions count toward the annual mandatory distributions required for traditional IRAs. This opportunity only extends to gifts made in 2006 and 2007 and to gifts made to public charities, excluding supporting organizations and donor advised funds. And, of course, taxpayers cannot take advantage of this provision and take a charitable deduction for their gift.

Form 990 Changes
Prior to the recent tax law changes, tax-exempt organizations whose gross receipts are normally not more than $25,000 were not required to file the federal annual information return, Form 990. Under the new law, those organizations still will not have to file Form 990, but they will have to file an annual “notice” with the IRS. The IRS will release a form to be used for notification purposes. It will be filed electronically and request the legal name of the organization, any name under which they operate and do business, their mailing and web site addresses, their taxpayer identification number, the name and address of a principal officer, and evidence of the continuing basis for their exemption from filing an information return. This new requirement applies for all annual periods beginning after 2006. A previously non-filing organization will need to provide its information for the first time in early 2008, with respect to its 2007 activities. Failure to meet this reporting requirement or to file a required Form 990 for three consecutive years will result in the revocation of an organization’s tax-exempt status. Note that this provision does not apply to certain organizations that continue to be exempt from the Form 990 filing requirement (e.g., churches or church-affiliated schools).

  • Under the new tax law, if tax-exempt organizations that are required to file Form 990 or the annual notice fail to do so for three consecutive years, that organization’s tax-exempt status will be revoked.
  • All supporting organizations, regardless of their gross receipts, are now required to file Form 990.
  • Organizations exempt under Section 501(c)(3) will now be required to disclose Schedule 990-T (reporting unrelated business income) to the public, with a few exceptions.

More Favorable Deductions for Certain Kinds of Donations
Now any taxpayer engaged in “a trade or business” is eligible to claim a more favorable tax deduction for the contribution of “apparently wholesome food” inventory. Prior to the act, only C corporations were eligible for the more favorable deduction. C corporations continue to be eligible for a more favorable deduction for a “qualified book contribution.” The new law retroactively extends the enhanced deduction for food donations made since January 1, 2006 but before December 31, 2007.

Also, donations of real property interests for a “qualified conservation purpose” are eligible for a more favorable charitable deduction.

More Restrictions on Other Kinds of Donations
If a taxpayer donates personal property for which he/she claimed a charitable deduction of more than $5,000 and that property is disposed of within three years by the organization that received the donation, then the taxpayer is subject to an adjustment of the tax benefit (i.e., the deductible amount must be revised).

A charitable deduction is only available for donations of clothing or household items if the items are in “good used condition or better.” More regulations are likely forthcoming on this issue (e.g., deductions for socks and underwear may be denied). This rule does not apply for items valued over $500 if a donor can provide a qualified appraisal.

Also, the act places greater restrictions on donations of real property interests in building facades located in a historic districts.

Record of Charitable Donations
The new law requires stricter recordkeeping requirements for charitable donations made after August 17, 2006. In order to receive a charitable deduction, the donor must now retain either a bank record or written communication from the charitable organization for all monetary donations, regardless of the amount. The written record of the donation must include the following information: 1) date of donation; 2) donee’s name; and 3) amount of donation. Charitable organizations, therefore, should consider supplying the donor with a written communication, containing the above mentioned information, for all donations.

Issues Affecting Supporting Organizations
Significant changes were made to the rules governing supporting organizations. The changes were less sweeping than initial proposals, but the new rules merit the attention of those
involved with supporting organizations. A full review of the changes is beyond the scope of this update, but a few issues are highlighted below.

  • For all types of supporting organizations, certain payments of compensation to any substantial contributor, or loans to any disqualified person or substantial contributor, of the supporting organization are prohibited. Such payments will be treated as automatic excess benefit transactions under Section 4958 of the Internal Revenue Code (the Intermediate Sanctions provisions) and subject to the applicable excise taxes. Note that a disqualified person of a supporting organization is also deemed to be a disqualified person in relation to the supported organization.
  • All types of supporting organizations now have to file Form 990, annual information return, regardless of their annual gross receipts. It will be required to certify that the supporting organization is not controlled by a disqualified person (other than its managers or supported organization).

Issues Affecting Donor Advised Funds
The act also included a number of provisions that make donor-advised funds less appealing and subject to increased regulation, including new rules related to substantiation prohibited distribution, automatic excess benefit transactions, investment advisors, and excess business holding rules. Both 501(c)(3) organizations and donors involved in donor advised funds need to review their situation carefully.

Excise Taxes Increased
A number of excise taxes relating to exempt organizations were increased by the act. Most importantly, for 501(c)(3) public charities and 501(c)(4) social welfare organizations, the fines for organization managers who participate in excess benefit transactions have increased from $10,000 to $20,000 per transaction. Various excise taxes applicable to private foundations also increased.

The foregoing is not intended as legal advice and is only a summary. If you have questions or would like additional information, please contact Melissa Auchard Scholz (608-284-2610 or mscholz@gklaw.com) or another member of either the Tax or Nonprofit Law Team.

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