The Charitable Reform Provisions of The Pension Protection Act of 2006

By Richard G. Cummings and Larry R. Garrison

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JANUARY 2007 - President George W. Bush signed the Pension Protection Act of 2006 into law on August 17, 2006. While its major emphasis is on pension reform, the Act also includes an extensive section on new rules regarding charitable donations and increased reporting and oversight over certain tax-exempt organizations. Subtitle A of the Act is titled “Charitable Giving Incentives.” Subtitle B, titled “Reforming Exempt Organizations,” is divided into three parts: “General Reforms,” “Improved Accountability of Donor Advised Funds,” and “Improved Accountability of Supporting Organizations.”

Charitable Giving Incentives (See Sidebar)

Tax-free distributions from individual retirement plans for charitable purposes. Section 1201 of the Act, amending IRC section 408, excludes from income an otherwise taxable distribution from an IRA that is a qualified charitable distribution. This exclusion is limited to $100,000 and applies to traditional and Roth IRAs. Distributions from IRC section 408(k) simplified employee pensions (SEP) or from section 408(p) savings incentive match plan for employees (SIMPLE) IRAs are not subject to the exclusion rules. A qualified charitable distribution is defined as a distribution made directly by the IRA trustee to an IRC section 170(b)(1)(A) charitable organization other than certain IRC section 509(a)(3) private foundations or section 4966(d)(2) donor-advised funds. The distribution must also be made on or after the date that the individual for whose benefit the plan is maintained has turned 70 Qs .

According to section 1201(a) of the Act, a distribution is treated as a qualified charitable distribution only to the extent the distribution would be includible in gross income without regard to this new provision. In addition, a distribution is treated as a qualified charitable distribution only if a deduction for the entire distribution would be allowable as a charitable contribution under IRC section 170.

According to section 1201(a) of the Act, for IRAs with nondeductible contributions, the entire amount of the distribution is treated as includible in gross income to the extent the amount does not exceed the aggregate amount that would have been includible if all amounts distributed from all IRAs were treated as one contract for determining the amount included under the IRC section 72 annuity rules. The proper adjustments are to be made in applying IRC section 72 to other distributions made in the taxable year and subsequent taxable years.

Example. Taxpayer T is more than 70 Qs years old and has a traditional IRA with a balance of $150,000. The balance consists of nondeductible contributions of $50,000 and deductible contributions, along with earnings of $100,000. T made a direct contribution of $100,000 to a qualified charity. Under the new provision, the distribution is treated as includible in gross income to the extent the amount does not exceed the aggregate amount that would have been includible if all amounts distributed from all IRAs were treated as one contract. Because T has a single IRA, the total amount includible in T’s income if all amounts were distributed is $100,000. Therefore, the entire $100,000 distribution to the charitable organization is treated as includible in T’s income and also as a qualified charitable distribution. Under the new provision, T would not report the $100,000 distribution from the traditional IRA in gross income and would not take the $100,000 as a charitable deduction for the year. This provision does not apply to nontaxable IRA distributions.

The new rules in sections 1201(a) and (c) of the Act regarding tax-free distributions from IRAs for charitable purposes apply to distributions made in taxable years beginning after December 31, 2005, and do not apply to distributions made in taxable years beginning after December 31, 2007. Thus, this new tax provision will have limited benefit, because only taxpayers 70 Qs years old will be able to benefit. Nevertheless, these taxpayers can avoid the prior limitations on AGI and the phase-outs on charitable deductions. Because the qualified charitable distribution under the new provision will not be included in income, it has the potential to provide the taxpayer an effective higher threshold for phasing out exemptions, a lower AMT, and possibly a lower state income tax liability.

The Act also modifies the reporting rules for information returns filed by certain trusts. Under prior law, split-interest trusts and trusts claiming certain charitable contributions were not required to file the usual information return if they were required to currently distribute all of their income. Under section 1201(b) of the Act, IRC section 4947(a)(2) split-interest trusts must file the required information return under IRC section 6034(a).

In addition, for trusts claiming certain charitable deductions, every trust not required to file an information return but claiming a deduction under IRC section 642(c) for the taxable year must furnish the following information, using the appropriate form:

  • Amount of the deduction taken under IRC section 642(c) within the year;
  • Amount paid out within such year which represents amounts for which deductions under IRC section 642(c) have been taken in prior years;
  • Amount paid out of principal in the current and prior years for the purposes described in IRC section 642(c);
  • Total income of the trust in the year, and expenses attributable to the income; and
  • Balance sheet showing assets, liabilities, and net worth to a trust as of the beginning of the year.

Section 1201(b) of the Act also provides that a trust claiming certain charitable deductions does not have to furnish the above information if all net income for the year is required to be distributed currently to the beneficiaries, or if the trust is described in IRC section 4947(a)(1).
Section 1201(b)(2) of the Act increases the penalty related to the failure to file an information return and the failure to include the required information by split-interest trusts. The penalty is $20 per day, with a maximum penalty of $10,000. In the case of a split-interest trust with gross income in excess of $250,000, the penalty is $100 per day, with a maximum penalty of $50,000. If the person required to file the return knowingly fails to file the return, the penalty is also imposed on that person, who will be personally liable for the penalty.

The new rules regarding returns apply to returns for taxable years beginning after December 31, 2006.

Charitable deduction for contributions of food inventory. Amending IRC section 170(e)(3)(D)(iv), section 1202 of the Act extends to December 31, 2007, the modification of the charitable deduction for contributions of food inventory enacted as part of the Katrina Emergency Tax Relief Act of 2005 (KETRA). (The end date had been December 31, 2005.) The modification under KETRA allowed for a contribution deduction equal to the lesser of the adjusted basis of the food inventory plus one-half of the profit that would have been realized if the inventory had been sold at fair market value, or twice the basis of the food inventory. Recipients of food donations need not, however, have been affected by Hurricane Katrina.

Basis adjustment to stock of an S corporation contributing property. Amending IRC section 1367(a)(2), section 1203 of the Act states that the amount of the reduction in the shareholder’s basis in S corporation stock by reason of a charitable contribution of property made by the S corporation is equal to the shareholder’s pro rata share of the adjusted basis of the property. Prior law allowed for a reduction in the basis of the stock for the amount of the charitable contribution that flowed through to the shareholder. The new rule applies to contributions made in taxable years beginning after December 31, 2005, but does not apply to contributions made in taxable years beginning after December 31, 2007.

Charitable deduction for contributions of book inventory. Amending IRC section 170(e)(3)(D)(iv), section 1204 of the Act extends to December 31, 2007, the modification of the charitable deduction for contributions of book inventory enacted as part of KETRA. (The end date had been December 31, 2005.) The modification under KETRA allowed for a deduction equal to the lesser of the adjusted basis of the contributed book inventory plus one-half of the profit that would have been realized if the inventory had been sold at fair market value, or twice the basis of the book inventory. Recipients of book donations need not, however, have been affected by Hurricane Katrina.

Tax treatment of certain payments to controlling exempt organizations. In section 1205, the Act amends IRC section 512(b)(13) by modifying the tax treatment of certain payments to controlling exempt organizations. Under prior law, IRC section 512(b)(13) treats income items such as interest, annuities, royalties, or rents as unrelated business income if the income is received from a taxable or tax-exempt subsidiary that is 50% controlled by the tax-exempt parent corporation. The controlling corporation includes the payment as an item of gross income derived from an unrelated trade or business to the extent the payment reduces the net unrelated income of the controlled entity or increases any net unrelated loss of the controlled entity. The Act modifies the treatment so that IRC section 512(b)(13) applies only to the portion of the qualifying specified payment received or accrued by the controlling organization that exceeds the amount that would have been paid or accrued if the payment met the IRC section 482 requirements regarding allocation of income and deductions among taxpayers.

In conjunction with this modification regarding excess payments, section 1205(a) of the Act imposes a 20% penalty tax on the larger of the excess determined without regard to any amendment or supplement to a return of tax, or the excess determined with regard to all such amendments and supplements.

Section 1205(c)(1) of the Act sets forth amendments to the IRC regarding certain excess payments that apply to payments received or accrued after December 31, 2005.

Section 1205(b) of the Act includes reporting requirements so that each controlling organization includes on their return:

  • Any interest, annuities, royalties, or rents received from each controlled entity;
  • Any loans made to each controlled entity; and
  • Any transfers of funds between the controlling organization and each controlled entity.

The U.S. Secretary of the Treasury is required under the Act [section 1205 (b)(2)] to submit to the Senate Finance Committee and the House Ways and Means Committee a report on the effectiveness of the IRS in administering the above changes and the extent to which the payments by controlled entities to controlling organizations meet the requirements of IRC section 482. The report must include the results of any audit of any controlling organization or controlled entity and recommendations relating to the tax treatment of payments from controlled entities to controlling organizations.

Section 1205(c)(2) of the Act includes amendments regarding reporting requirements that apply to returns with a due date after August 17, 2006.

Contributions of capital gain real property made for conservation purposes. The current 30% contribution base limitation is increased to 50% by section 1206 of the Act, amending IRC section 170(b)(1), for qualified conservation contributions of capital gain property by individuals. The Act states that any qualified conservation contribution is allowed to the extent the aggregate of the contributions does not exceed the excess of 50% of the taxpayer’s contribution base (generally, AGI) over the amount of all other charitable contributions allowable under IRC section 170(b)(1). Any qualified conservation contributions in excess of the 50% limitation may be carried over for up to 15 years.

Under section 1206(a)(1) of the Act, a qualified farmer or rancher is allowed a qualified conservation contribution to the extent the aggregate of the contributions does not exceed the excess of 100% of the taxpayer’s contribution base over the amount of all other allowable charitable contributions. A qualified farmer or rancher is a taxpayer whose gross income from the trade or business of farming is greater than 50% of the taxpayer’s gross income for the taxable year.

According to section 1206(a)(2), if the qualified farmer or rancher is a corporation whose stock is not readily tradable on an established securities market, then a qualified conservation contribution is allowable up to 100% of the excess of the corporation’s taxable income, computed under IRC section 170(b)(2), over the amount of all other allowable charitable contributions. Excess contributions may be carried forward for up to 15 years as a contribution subject to the 100% limitation.

The Act includes an additional requirement [section 1206(a)(1)] for any contribution of property used in agriculture or livestock production. The 100% limitation does not apply to any contribution of property used in agriculture or livestock production, or available for such production, unless the contribution is subject to a restriction that the property remain available for production. This additional requirement applies to contributions of property made after August 17, 2006.

According to section 1206(a)(1) of the Act, except as noted in the above paragraph, the amendments apply to contributions made in taxable years beginning after December 31, 2005, and do not apply to contributions made in taxable years beginning after December 31, 2007.

Excise tax exemption for blood-collector organizations. Section 1207(a) of the Act, amending IRC section 4041(g), provides that certain blood-collector organizations are exempt from certain excise taxes with respect to activities related to blood collection. The Act includes an exemption from the IRC section 4041 diesel fuel and special motor fuels tax on the sale of any liquid to a qualified blood-collector organization for the organization’s exclusive use in the collection, storage, or transportation of blood.

The Act amends IRC section 4221(a) to provide an exemption from the Chapter 32 manufacturers excise tax on the sale of an article to a qualified blood-collector organization for the organization’s exclusive use in the collection, storage, or transportation of blood [section 1207(b)].

Section 1207(c) of the Act, amending IRC section 4253, includes an exemption from the IRC section 4251 communications excise tax on any amount paid by a qualified blood-collector organization for services or facilities furnished to the organization.

The Act amends IRC section 4483 and provides for an exemption from the IRC section 4481 excise tax on certain motor vehicles [section 1207(d)]. The Act states that no tax will be imposed on the use of any qualified blood-collector vehicle by a qualified blood-collector organization. A qualified blood-collector vehicle is a vehicle at least 80% of the use of which during the prior taxable period was by a qualified blood-collector organization in the collection, storage, or transportation of blood. If the vehicle is first placed in service in a taxable period, a vehicle is treated as a qualified blood-collector vehicle if the qualified blood-collector organization certifies that it reasonably expects at least 80% of the use of the vehicle will be in the collection, storage, or transportation of blood.

Section 1207(f) of the Act defines a qualified blood-collector organization as an organization that is—

  • Described in IRC section 501(c)(3) and exempt from tax under section 501(a);
  • Primarily engaged in the activity of the collection of human blood;
  • Registered with the U.S. Secretary of the Treasury for purposes of excise tax exemptions; and
  • Registered with the U.S. Food and Drug Administration (FDA) to collect blood.

According to section 1207(g), the Act’s provisions generally take effect on January 1, 2007, except for the provisions related to the exemption from the excise tax on vehicles used in blood collection, which applies to taxable periods beginning on or after July 1, 2007.

General Reforms

Reporting on certain acquisitions of interests in insurance contracts. Prior law contained no reporting requirements for acquisitions by exempt organizations of interests in insurance contracts. Section 1211(a)(1) of the Act adds IRC section 6050V, thereby including a reporting requirement as well as requiring a published report by the U.S. Department of the Treasury with respect to acquisitions of interests in insurance contracts in which certain exempt organizations hold an interest. For acquisitions subject to the reporting requirements occurring between August 17, 2006, and August 18, 2008, an applicable exempt organization that makes a reportable acquisition must file an information return. A general failure-to-file penalty is assessed if the information return is not filed, with a penalty of 10% of the value of the benefit of any contract being assessed if the failure to file is due to intentional disregard of the filing requirement.

A reportable acquisition is defined by section 1211(c)(1) of the Act as “the acquisition by an applicable exempt organization of a direct or indirect interest in any applicable insurance contract in any case in which such acquisition is a part of a structured transaction involving a pool of such contracts.” An applicable insurance contract is defined as “any life insurance, annuity, or endowment contract with respect to which both an applicable exempt organization and a person other than an applicable exempt organization have directly or indirectly held an interest in the contract (whether or not at the same time).” The Act directs the U.S. Secretary of the Treasury to undertake a study on the use by tax-exempt organizations of applicable insurance contracts for the purpose of sharing the benefits of the organization’s insurable interest in insured individuals under such contracts with investors, and on whether such activities are consistent with the tax-exempt status of such organizations.

Increase in penalty excise taxes. Section 1212 of the Act, amending IRC sections 4941–4945 and 4958, doubles the amount of the penalty assessed under current law in the form of excise taxes relating to public charities, social welfare organizations, and private foundations. Increased penalty percentages and increased dollar limitation amounts apply to self-dealing and excess-benefit transactions by exempt-organization managers. Penalty percentages and dollar limitations are also doubled for a failure to distribute income, having excess business holdings, holding investments that jeopardize the charitable purpose, and taxable expenditures. The increased penalties are applicable for tax years beginning after August 17, 2006.

Contributions of certain easements. Section 1213 of the Act, amending IRC section 170(h)(4), allows for the charitable contribution of easements of buildings located in a registered historic district, effective after July 25, 2006. To qualify for deductibility, the easement must include a restriction that preserves the entire exterior of the building and prohibits any change in the exterior of the building that is inconsistent with the historical character of the exterior.

The Act also provides that, for contributions relating to a registered historic district made in a tax year beginning after August 17, 2006, a taxpayer must include a qualified appraisal, a photograph of the entire exterior of the building, and a description of all restrictions on the development of the building. Failure to include all of this documentation with the return will result in disallowance of the deduction.

Furthermore, the Act requires the donor and the donee to enter into a written agreement certifying, under penalty of perjury, that the donee is a qualified organization with a purpose of environmental protection, land conservation, open-space preservation, or historic preservation, and has the resources to manage and enforce the restriction and a commitment to do so.

Under the new law, no deduction in excess of $10,000 is allowed for a qualified conservation contribution with respect to the exterior of a building located in a registered historic district unless a $500 filing fee is paid with the return [section 1213(c) of the Act, amending IRC section 170(f)(13)]. If the fee is not paid, the deduction is disallowed. This rule is in effect for contributions made after February 13, 2007.

In addition, section 1213(d) of the Act, amending IRC section 170(f)(14), states that the charitable deduction is reduced if a rehabilitation tax credit has been claimed with respect to the donated property for contributions made after August 17, 2006.

Charitable contributions of taxidermy property. Section 1214 of the Act amends IRC sections 170(e)(1)(B)(iv) and 170(f), dealing with the contribution of taxidermy property. Under prior law, charitable contributions are subject to rules which state that, for appreciated property, the deduction is equal to the fair market value if the property is used to further the donee’s exempt purpose. The deduction is equal to the donor’s basis if the property is not used to further the donee’s exempt purpose. If the property is depreciated such that the fair market value is less than the taxpayer’s basis in the property, the taxpayer may generally deduct the fair market value of the contribution regardless of whether or not the property is used for the donee’s exempt purpose.

Under the Act, the taxpayer’s basis in the donated taxidermy property is limited to the cost of preparing, stuffing, or mounting the taxidermy property. The amount allowed as a charitable contribution of taxidermy property contributed by the person who prepared, stuffed, or mounted the property, or by any person who paid or incurred the cost of such preparation, stuffing, or mounting, is the lesser of the taxpayer’s basis in the property or the fair market value of the property. This rule applies to contributions made after July 25, 2006.

Tax benefit for contributions of exempt-use property not used for an exempt purpose. The Act provides for a recapture of the previous tax benefit received from a prior contribution deduction by stating that if a donee organization makes an “applicable disposition” of “applicable property,” then the donor of the property includes in income in the taxable year in which the applicable disposition occurs an amount equal to the excess, if any, of the amount of the allowed deduction over the donor’s basis at the time of contribution [section 1215 of the Act, amending IRC sections 170(e), 170(e)(1)(B)(i), and 6050L(a)]. The Act defines “applicable disposition” as any sale, exchange, or other disposition by the donee of applicable property after the last day of the taxable year of the donor in which the property was contributed and before the last day of the three-year period beginning on the date of the contribution of the property unless the donee makes a proper certification. “Applicable property” is charitable deduction property defined under IRC section 6050L(a)(2)(A), which is tangible personal property, the use of which is identified by the donee as related to the purpose or function constituting the basis of the donee’s exemption and for which a deduction in excess of the donor’s basis is allowed.

No recapture is necessary if proper certification is made. Proper certification is a written statement signed under penalty of perjury by an officer of the donee organization which certifies that the use of the property by the donee was related to the purpose or function constituting the basis for the donee’s exemption, describing how the property was used and how the use furthered such purpose or function, and certifying that the intended use has become impossible or infeasible to implement. The recapture rule applies to contributions made after September 1, 2006.

Section 1216 of the Act, adding IRC section 170(f), provides that for identifications made after August 17, 2006, a $10,000 penalty is assessed for the fraudulent identification of exempt-use property.

Deduction for clothing and household items. The new law disallows a deduction for any contribution of clothing or a household item unless the item is in good used condition or better [section 1216(c) of the Act, adding IRC section 170(f)]. The Act does not define “good used condition,” but defines household items as furniture, furnishings, electronics, appliances, linens, and other similar items. The Act states that household items do not include food, paintings, antiques, other objects of art, jewelry, gems, or collections. The new law also states that the IRS may disallow a deduction for any contribution of clothing or household item with minimal monetary value. A deduction is allowed for any contribution of an item of clothing or a household item not in good used condition or better if the amount claimed for the item is more than $500 and the taxpayer includes with the return a qualified appraisal with respect to the property. This rule applies to contributions made after August 17, 2006.

Recordkeeping requirements for certain charitable contributions. The IRC section 170(f) recordkeeping requirements are amended by section 1217 of the Act, which provides that no deduction shall be allowed for any contribution of a cash, check, or other monetary gift unless the donor maintains as a record of the contribution a bank record or a written communication from the donee showing the name of the donee organization, the date of the contribution, and the amount of the contribution. This new rule applies for contributions made in tax years beginning after August 17, 2006.

This new requirement means that, regardless of amount, any cash contribution must be substantiated by a cancelled check, a listing on a bank statement, or a credit card statement.

Fractional interests in tangible personal property. Section 1218 of the Act, amending IRC sections 170, 2055, and 2522, adds special rules for contributions, bequests, and gifts of fractional interests in tangible personal property. No deduction is allowed for a contribution of an undivided portion of a taxpayer’s entire interest in tangible personal property unless all interest in the property is held immediately before the contribution by the taxpayer or the taxpayer and the donee. Exceptions may be made where all persons who hold an interest in the property make proportional contributions of an undivided portion of the entire interest held by such persons. For the valuation of subsequent gifts, the fair market value of an additional contribution is determined by using the lesser of the fair market value of the property at the time of the initial fractional contribution, or the fair market value of the property at the time of the additional contribution.

The Act also provides for the recapture of the amount of any deduction allowed with respect to any contribution of an undivided portion of a taxpayer’s entire interest in tangible personal property in any case in which the donor does not contribute all of the remaining interest in the property to the donee before the earlier of 10 years after the date of the initial fractional contribution, or the date of the death of the donor. Recapture will also occur if the donee has not had substantial physical possession of the property and used the property in a use that is related to the organization’s exempt purpose or function. The tax benefit would be recaptured along with interest and a 10% penalty.

Substantial and gross overstatements of valuations. The prior law imposed accuracy-related penalties on taxpayers making a substantial valuation misstatement or gross valuation misstatement relating to an underpayment of the income tax. The IRC also provided for an accuracy-related penalty imposed on taxpayers who make a substantial or gross estate- or gift-tax valuation understatement. A penalty could also be assessed on persons for aiding or abetting another taxpayer’s understatement of tax.

The Act lowers the threshold for accuracy-related penalties imposed on taxpayers for returns filed after August 17, 2006 [section 1219 of the Act, amending IRC sections 6662(e) and (g)]. It lowers the substantial valuation misstatement percentage for income taxes from 200% to 150%, and raises the substantial valuation misstatement percentage for estate or gift taxes from 50% to 65%. The increased gross valuation misstatement percentages for income taxes and estate and gift taxes are likewise changed.

The Act establishes a new civil penalty on any person who prepares an appraisal to be used in conjunction with a return or a claim for refund who knows, or reasonably should have known, that the claimed value of the appraised property results in a substantial valuation misstatement or a gross valuation misstatement.

The appraiser penalty is equal to the lesser of the following:

  • The greater of 10% of the amount of underpayment attributable to the misstatement, or $1,000; or
  • 125% of the gross income received by the appraisal for preparation of the appraisal.

According to section 1219(b)(1) of the Act, which adds IRC section 6695A(a), the penalty is waived if the appraiser can establish that the appraised value was more likely than not to be the proper value. The penalty applies to appraisals prepared with respect to returns or submissions filed after August 17, 2006.

Additional Standards for Credit Counseling Organizations

Prior law provided for the possible exemption of a credit counseling organization as a charitable or educational organization under IRC section 501(c)(3) or as a social welfare organization under section 501(c)(4). Section 1220 of the Act establishes, in addition to general pre-Act exemption rules, certain requirements that a
credit counseling organization must meet in order to operate as an exempt organization under IRC section 501(c)(3) or (c)(4).

To receive or maintain tax-exempt status, an organization with credit counseling services as its substantial purpose must satisfy the following criteria:

  • The organization must not solicit contributions from consumers during the initial counseling process or while the consumer is receiving services from the organization; and
  • The aggregate revenues of the organization from payments of creditors of consumers of the organization attributable to debt-management plan services must not exceed 50% of the total revenues of the organization.

Debt-management services include services related to the repayment, consolidation, or restructuring of a consumer’s debt, along with negotiation with creditors of lower interest rates, the waiving or reduction of fees, and the marketing and processing of debt management plans. Sections 1220(a) and 1220(b) of the Act amend IRC section 501 and specify that debt-management plan services are unrelated business income for any organization that is not a credit counseling organization.

The new requirements are effective for tax years beginning after August 17, 2006, for new organizations, and effective for tax years beginning after August 17, 2007, for existing organizations. The new law also provides for a four-year transition rule.

Expanded Base of Tax on Private Foundation Net Investment Income

Prior law assessed tax-exempt private foundations a 2% excise tax on net investment income. Taxable private foundations are subject to an excise tax based on net investment income and unrelated business income. For both tax-exempt and taxable private foundations, net investment income is defined as the amount by which the sum of gross investment income and capital gain net income exceed the deductions relating to the production of gross investment income.

Section 1221 of the Act, amending IRC section 4940, changes the definition of gross investment income to include capital gains, notional principal contracts, annuities, and other substantially similar forms of investment income. The revised definition applies to tax years beginning after August 17, 2006.

Conventions or Associations of Churches

Section 1222 of the Act, amending IRC section 7701, clarifies the definition of a “convention or association of churches” by providing that an organization that otherwise is a convention or association of churches does not fail to so qualify merely because the membership of the organization includes individuals as well as churches, or because individuals have voting rights in the organization. The clarification is effective on August 17, 2006.

Notification Requirement for Entities Not Currently Required to File (See Sidebar)

Organizations that do not have an annual filing requirement because their gross receipts are less than $25,000 must file an annual notice with the IRS [section 1223(a) of the Act, amending IRC section 6033] containing:

  • The legal name of the organization;
  • Any name under which the organization operates or does business;
  • The organization’s mailing address and website address, if any;
  • The organization’s taxpayer identification number;
  • The name and address of the principal officer; and
  • Evidence of the continuing basis for the organization’s exemption from the filing requirements.

If an organization fails to file the required annual return or notice for three consecutive years, the organization’s exempt status will be considered revoked on and after the date set for filing of the third annual return or notice [section 1223(b) of the Act, amending IRC section 6033]. A retroactive reinstatement is provided for if reasonable cause for failure to file can be shown.

Sections 1223(e) and (f) of the Act, amending IRC section 6033, direct the U.S. Secretary of the Treasury to notify in a timely manner every organization described under IRC section 6033 of the notice requirement. This new requirement applies to notices and returns for annual periods beginning after 2006.

Disclosure to State Officials Relating to Exempt Organizations

Under the new law [section 1224(a) of the Act, amending IRC section 6104], the IRS may disclose the following information to an appropriate state official:

  • A notice of proposed refusal to recognize an organization as tax-exempt or a notice of proposed revocation of an organization’s tax-exempt status;
  • Issuance of a letter of proposed deficiency of tax; and
  • Names, addresses, and taxpayer identification numbers of organizations that have applied for recognition as tax-exempt organizations.

This information may be disclosed or inspected only upon written request by an appropriate state officer and for the purpose of, and only to the extent necessary to, the administration of state laws regulating such organizations. The disclosure provisions apply to a written request by an appropriate state official on or after August 17, 2006.

Section 1224(a) of the Act specifies that the “appropriate state officer” includes:

  • The state attorney general;
  • The state tax officer;
  • Any other state official charged with overseeing organizations described in IRC section 501(c)(3); and
  • The head of an agency designated by the state attorney general as having primary responsibility for overseeing the solicitation of funds for charitable purposes for organizations other than IRC section 501(c)(1) or (c)(3) organizations.

Public Disclosure of Information Relating to UBIT Returns

Under prior law, an organization described in IRC section 501(c) or 501(d) had to make available for public inspection its Form 990, Return of Organization Exempt From Income Tax, and the applicable exempt-status application materials.

Section 1225 of the Act, amending IRC section 6104(d)(1)(A), extends the public inspection and disclosure requirements applicable to the Form 990 to IRC section 501(c)(3) organizations filing Form 990-T, Exempt Organization Business Income Tax Return. Form 990-T reports the unrelated business taxable income (UBTI) of an otherwise tax-exempt organization. The expanded disclosure requirements apply to returns filed after August 17, 2006.

Donor-Advised Funds and Supporting Organizations

A donor-advised fund is a fund established by a charitable organization where the donor provides advice regarding distributions from the fund or the investment of fund assets.

Section 1226(a) of the Act requires the U.S. Secretary of the Treasury to undertake a study on the organization and operation of IRC section 4966(d)(2) donor-advised funds and organizations described in IRC section 509(a)(3). The study is to specifically consider the following:

  • Whether the deductions (income, gift, or estate taxes) allowed for charitable contributions to IRC section 4966(d)(1) sponsoring organizations of donor-advised funds, or to IRC section 509(c)(3) organizations, are appropriate in consideration of—
    • The use of contributed assets, including the type, extent, and timing of such use, or
    • The use of the assets of such organizations for the benefit of the person making the charitable contribution or of a person related to such person.
  • Whether donor-advised funds should be required to distribute a specified amount (whether determined by income or assets) for charitable purposes in order to ensure that the sponsoring organization with respect to the donor-advised fund is operating consistent with the purposes or functions constituting the basis for its exemption under IRC section 501 or its status as an IRC section 509(a) organization.
  • Whether the retention by donors to donor-advised organizations of rights or privileges with respect to amounts transferred to such organizations is consistent with the treatment of such transfers as completed gifts that qualify for a deduction for income, gift, or estate taxes.
  • Whether the above are also issues with respect to other forms of charities or charitable donations.

Section 1226(b) of the Act specifies that the study is to be submitted to the Senate Committee on Finance and the House Ways and Means Committee, along with recommendations, not later than one year after August 17, 2006.

Improved Accountability of Donor-Advised Funds (See Sidebar)

In addition to the required Treasury study mentioned above, the Act amends several IRC provisions reflecting a concern that donors may be abusing the current provisions regarding donor-advised funds. A section of the Act is titled “Improved Accountability of Donor Advised Funds” and includes the following five sections (Act Sections 1231-1235):

Excise taxes. Section 1231(a) of the Act adds IRC section 4966 to IRC chapter 42, subchapter G, “Donor Advised Funds.” This new law imposes a 20% excise tax on the sponsoring organization on each taxable distribution. A taxable distribution is defined as any distribution from a donor-advised fund to a person if the distribution is for any purpose other than one specified under the charitable contribution definitions of IRC section 170(c)(2)(B), or if the sponsoring organization does not exercise expenditure responsibility as defined under IRC section 4945(h) with respect to such distribution.

In addition, under the new IRC section 4966, the Act imposes a 5% excise tax to be paid by the fund manager who agreed to make the taxable distribution knowing it was a taxable distribution.

Section 1231(a) of the Act also adds section 4967 to IRC chapter 42, subchapter G. Under IRC section 4967, the Act imposes an excise tax on prohibited benefits. An excise tax is imposed on the donor, donor advisor, or a related person who gives advice to a sponsoring organization making a distribution from a donor-advised fund that results in the donor, donor advisor, or related person receiving, directly or indirectly, a more than incidental benefit as a result. The excise tax is equal to 125% of the benefit.

IRC section 4967 imposes a 10% excise tax on a fund manager who agrees to make the taxable distribution knowing it would confer a prohibited benefit.

These new excise taxes are effective for taxable years beginning after August 17, 2006.

Excess-benefit transactions. Section 1232 of the Act, amending IRC section 4958(f) expands the definition of disqualified persons for purposes of the excise tax on excess-benefit transactions to donors, donor advisors, and investment advisors of donor-advised funds and sponsoring organizations. The provisions apply to transactions occurring after August 17, 2006.

Excess business holdings. The Act expands the application of the excise tax on excess business holdings to donor-advised funds. The amendments to IRC section 4943 made by section 1233 of the Act apply to taxable years beginning after August 17, 2006.

Treatment of charitable contribution deductions. Section 1234(a) of the Act, amending IRC section 170(f), provides that contributions to certain sponsoring organizations with respect to a donor-advised fund are deductible if the sponsoring organization is not one of the following types of entities:

  • IRC section 170(c)(3) war veterans organization;
  • IRC section 170(c)(4) domestic fraternal lodge;
  • IRC section 170(c)(5) cemetery organization; or
  • A Type III supporting organization as defined in IRC section 4943(f)(5)(A) that is not a “functionally integrated” type III supporting organization as defined in IRC section 4943(f)(5)(B).

Section 1234(b) and (c) of the Act, amending IRC sections 2055(e) and 2522(c), respectively, include similar language regarding contributions to donor-advised funds for estate and gift tax purposes.

The provisions apply to contributions made after February 13, 2007.

Returns of, and applications for recognition by, sponsoring organizations. Section 1235(a) of the Act requires that sponsoring organizations to donor-advised funds include the following on their annual return filed under the amended IRC section 6033:

  • A list of the total number of donor-advised funds owned at the end of the taxable year;
  • The aggregate value of assets held in such funds at the end of the taxable year; and
  • The aggregate contributions to and grants made from such funds during the taxable year.

Section 1235(b) of the Act, amending IRC section 508, requires that sponsoring organizations give notice in their exempt-status application as to whether the organization maintains or intends to maintain donor-advised funds, and the manner in which the sponsoring organization plans to operate such funds.

The new provisions apply to organizations’ returns filed for taxable years ending after August 17, 2006, and applications for exempt status filed after this date.

Improved Accountability of Supporting Organizations

In addition to donor-advised funds, the Act’s provisions also address supporting organizations related to donor-advised funds.

Requirements for supporting organizations. Section 1241 of the Act, amending IRC section 509, requires supporting organizations to provide such information as required by the U.S. Secretary of the Treasury to ensure that the supporting organization is responsive to the needs or demands of the supported organization. The new provisions take effect August 17, 2006.

Excess-benefit transactions. The definition of disqualified persons for purposes of the excise tax on excess-benefit transactions to supporting organizations is expanded by section 1242(a) of the Act, amending IRC section 4958(f). The amendments made by section 1242(a) apply to transactions occurring after August 17, 2006.

The new law expands the definition of certain transactions treated as excess-benefit transactions [section 1242(b) of the Act, amending IRC section 4958(c)]. For supporting organizations, the term includes any grant, loan, compensation, or other similar payment provided by the organization to a substantial contributor to the organization, a member of the family as determined under IRC section 4958(f)(4), or a 35% controlled entity; or any loan provided by such organization to a disqualified person.

Section 1242(b) of the Act, amending IRC section 4958(c), defines a substantial contributor as any person who contributed or bequeathed an aggregate amount of more than $5,000 to the organization, if such amount is more than 2% of the total contributions and bequests received by the organization before the close of the taxable year. These amendments apply to transactions occurring after July 25, 2006.

Excess business holdings. Section 1243 of the Act, amending IRC section 4943, expands the application of the excise tax on excess business holdings to supporting organizations. The amendments apply to taxable years beginning after August 17, 2006.

Amounts paid to supporting organizations by private foundations. Section 1244 of the Act, amending IRC section 4942(g), concerns taxes on the undistributed income of a private foundation. The term “qualifying distributions” no longer includes certain distributions by nonoperating private foundations to supporting organizations. It applies to distributions and expenditures made after August 17, 2006.

Returns of supporting organizations. Supporting organizations to donor-advised funds must, under section 1245 of the Act, amending IRC section 6033, do the following on their annual return filed under IRC section 6033:

  • List the IRC section 509(f)(3) supported organizations to which the organization provides support;
  • Indicate whether the organizations meet the requirements of IRC section 509(a)(3)(B)(i), (ii), and (iii); and
  • Certify that the organization meets the requirements of IRC section 509(a)(3)(C).

These new provisions apply to organizations’ returns filed for taxable years ending after August 17, 2006.


Richard G. Cummings, PhD, CPA, is an assistant professor of accounting at the University of Wisconsin–Whitewater, Whitewater, Wisc.
Larry R. Garrison, PhD, CPA, is a professor of taxation in the department of accountancy at the University of Missouri–Kansas City, Kansas City, Mo.

 


 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 



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