Washington News: December - Week 3 - 2015
Permanent IRA Rollover!
The Protecting Americans From Tax Hikes (PATH) Act of 2015 was passed by votes of 318 to 109 in the House and 65 to 33 in the Senate. With bipartisan support, the bill makes permanent four tax extenders that help donors support their favorite charities. President Obama signed the PATH Act on December 18, 2015.
The four permanent charitable provisions include the following:
- IRA Charitable Rollover – Each IRA owner over age 70½ may make a transfer of up to $100,000 per year to a qualified charity. IRA charitable rollovers are tax-free and not included in adjusted gross income. An IRA charitable rollover may fulfill part or all of your required minimum distribution (RMD).
- Conservation Gift Limits – Gifts of property for conservation purposes benefit from increased deduction limits. The normal 30% of adjusted gross income (AGI) limit for appreciated property gifts is increased to 50% and the carryforward limit is extended from five years to 15 years. For qualified farmers and ranchers, the deduction limit is 100% of AGI.
- Food Inventory Gifts – An enhanced deduction for contributions of "apparently wholesome" food will be available for all donors. The deduction is the lesser of twice the basis or basis plus one-half of the appreciation. The deduction limit is raised to 15%.
- S Corporation Appreciated Gifts – A Subchapter S corporation may give appreciated stock or land to charity. Only the basis of the S corporation in the donated asset will be used to reduce the shareholder basis, even though the full fair market value deduction is claimed by the shareholder.
Editor’s Note: A permanent IRA Charitable Rollover is very good news for all friends of philanthropy. Donors may now plan with certainty to help their favorite charities through an IRA gift. Because the IRA rollover gift is not reported in taxable income, it is a very convenient and simple way to help charity. It also may simplify your tax return by reducing your adjusted gross income.
PATH Bill Praise
The PATH Act received solid majority support from both parties in the House and Senate. This support is also reflected in public statements made by leaders in Congress and the White House. In a joint release, Senate Finance Committee Chairman Orrin Hatch (R-UT), Ranking Member Ron Wyden (D-OR) and Chairman of the House Ways and Means Committee Kevin Brady (R-TX) gave strong support to the PATH Act.
Chairman Hatch noted, “After years of short-term extensions, good faith bipartisan compromise prevailed. The result? A strong common-sense deal that puts in place permanent and responsible tax relief to help businesses, families and individuals keep more of their hard-earned dollars and promote greater economic growth here at home.”
Sen. Wyden commented, “Millions of working families with children will not find themselves suddenly taxed into poverty. Millions of college students won’t have the rug pulled out from under them when the tuition bill arrives. Charities can confidently plan and expand the good work they do. And small businesses and enterprises on the forefront of innovation now have the economic certainty they deserve.”
Chairman Brady continued, “By delivering permanent tax relief, we are making it easier for Americans to keep more of their own money, find new jobs, and increase their wages. Businesses will also be able to invest with confidence in new equipment, research and jobs to grow the local economy.”
The White House also promptly indicated its support for the bill. A White House release stated, “In addition to making permanent vital improvements to tax credits for working and middle-class families, this legislation also would bring certainty to small businesses, companies investing in U.S. innovation, and charities, while extending important incentives for hiring and investing in the low-income community.”
The Alliance for Charitable Reform is a project of the Philanthropy Roundtable. Alliance Executive Director Sandra Swirski also approved and stated, “We are pleased that the year-end tax bill provides certainty to donors and charities by permanently extending three key charitable giving incentives.” She expressed her appreciation to Congress for listening to the philanthropy sector.
Editor’s Note: Chairman Brady and Chairman Hatch both expressed confidence that making the tax extenders permanent will open the door to major tax reform in 2016. Both have set a goal to lower tax rates, while recognizing that there will be limitations on itemized deductions to achieve that goal. Under the Congressional rules, this bill enables a future major tax reform act to lower rates with substantially fewer reductions in itemized deductions.
JCT Explanation of PATH Bill
With major tax legislation, the Congressional Joint Committee on Taxation (JCT) publishes a detailed explanation of the tax changes. This JCT explanation covers the specific impact on philanthropy of ten PATH sections.
Sec. 111 Conservation Gifts
Donors who are interested in a deduction for benefiting the environment must meet three specific standards. They must donate a qualified real property interest to a qualified charitable organization exclusively for conservation purposes. Approved conservation purposes include preservation of land for outdoor recreation, protection of wildlife habitat, preservation of open space or preservation of a historically important area or structure.
The PATH Act makes permanent favorable rules for gifts of qualified conservation property. Instead of the normal appreciated property limit of 30% of adjusted gross income (AGI), conservation gifts may be deducted up to 50% of AGI. The deduction at fair market value will be considered after all other gifts. In addition, rather than the normal 5 year carryforward, a conservation gift qualifies for a carryforward for up to 15 years. Sec. 170(b)(1)(E).
Farmers and ranchers who derive a minimum of 50% of their gross income from that activity qualify for a higher limit. They may deduct conservation gifts at the appraised fair market value up to 100% of AGI, with a carryforward for 15 years. Sec. 170(b)(2)(B).
Sec. 112 IRA Charitable Rollovers
IRA owners who are over age 70½ are required to take a minimum distribution each year. In nearly all cases, this distribution from a traditional IRA produces ordinary income for the recipient.
A “qualified charitable distribution” is now permitted for transfers from the IRA custodian directly to a qualified charity. IRA owners over age 70½ may transfer up to $100,000 per year to a Sec. 170(b)(1)(A) charity. The public charity may not be a supporting organization or a donor advised fund.
The QCD may be used to fulfill the required minimum distribution (RMD) for the year of the transfer. Because the QCD is not included in taxable income, there is no reported charitable deduction. Sec. 408(d)(8). However, transferring the QCD amount directly to charity rather than taking a distribution and writing a check to charity results in a lower adjusted gross income (AGI). This may save both ordinary tax and alternative minimum tax.
Editor’s Note: The PATH Act does not extend to IRA rollovers to charitable gift annuities or charitable remainder trusts. The Charitable IRA Initiative and other nonprofits are seeking to obtain approval for IRA Rollovers to life income gifts in a future tax act.
Sec. 113 Gifts of Food Inventory
Because under Sec. 170(e)(1)(A) gifts of ordinary income property are not deductible, most gifts of inventory are deductible only at cost basis. An exception exists for C corporation gifts for the care of the ill, needy or infants. These may qualify for an enhanced deduction equal to the lesser of basis plus one-half of the appreciation or twice the basis.
Under the PATH Act, all taxpayers with inventory may give “apparently wholesome food” and receive an enhanced deduction. The deduction is the lesser of basis plus one-half of the appreciation or twice the basis. While the deduction was previously limited to 10% of income from proprietorship, partnership, Subchapter S corporation or C corporation taxable net income, the PATH Act expands this limit to 15%.
For organizations that do not account for inventory under Sec. 471 and are not capitalizing indirect costs under Sec. 263A, there is an election to treat basis as 25% of fair market value. This election will permit a deduction for 50% of fair market value.
In addition, the valuation of inventory will not be determined by the taxpayer’s internal standards, a lack of market or other circumstances. The value will be based on external criteria.
Sec. 114 Payments by Controlled Subsidiaries
Under Sec. 512(b)(13), payments by a controlled subsidiary to a charitable parent, even if rent, royalty, annuity, or interest income, produce Sec. 512(b)(13) unrelated business taxable income. Control is defined as over 50% of the stock or beneficial interests in the controlled entity.
The PATH Act makes permanent the Sec. 482 (arms-length transaction) provision for payments by the controlled subsidiary. If the payments meet a fair market value standard for the rent or other amounts, there will not be unrelated business taxable income.
Sec. 115 Subchapter S Appreciated Property Gifts
With a Subchapter S Corporation there is a shareholder basis in the stock and a Subchapter S corporate basis in any appreciated assets owned by the entity. Previously, Sec. 1367(a)(2) required a reduction for appreciated property gifts that flowed through to the shareholder in the amount of the fair market value of the property.
The PATH Act makes permanent the rule that a gift by a Subchapter S Corporation of appreciated property to a qualified charity may flow through to the shareholders with the outside shareholder basis reduced by the inside corporate basis, not the full fair market value of the transfer.
Sec. 344 NIMCRUT Terminations
Under Sec. 664(d) a charitable unitrust may utilize a standard payout, a net income only payment (NICRUT) or a net income plus makeup payout (NIMCRUT). The unitrust must make a minimum 5% payout, have a maximum payout permitted of 50% and must have a minimum charitable deduction interest of 10%. Distributions from a unitrust are first ordinary income, then capital gain, then other (tax-free payouts) and finally principal.
Unitrusts may be terminated under state law. Termination may require notice to the state attorney general. The termination will require a valuation of the income and remainder interests.
Previously, the IRS had taken the position that an income interest for a NICRUT or NIMCRUT was valued using the lesser of the applicable federal rate or the stated unitrust payout percentage for the payout percentage. Under the PATH Act, the NICRUT or NIMCRUT valuation will be the same as a standard unitrust. The stated unitrust payout percentage will be used, “with any net income limit being disregarded.”
Sec. 404 IRS Action on Exempt Applications
Nonprofit organizations are expected to file IRS Form 1023 within 15 months of the end of the month in which they are formed in order to obtain exempt status. If they comply with that requirement and obtain exempt status, then all charitable deductions relate back to the date of formation. The IRS issues a favorable determination letter based on the Form 1023 information. However, the IRS also retains the right to suspend or revoke exempt status after conducting an examination, issuing a letter of proposed revocation and allowing various appeal rights.
The PATH Act requires the IRS to publish formal procedures to explain the administrative appeal actions for an applicant who wishes to work with the IRS Internal Office of Appeals.
Sec. 405 Notice for Sec. 501(c)(4) Organizations
Section 501(c)(4) permits social welfare organizations to have exempt status. They were not previously required to notify or obtain exempt status approval from the IRS.
The PATH Act requires a notice on a form to be developed by the IRS to be given within 60 days of formation of the new Sec. 501(c)(4) organization. There also may be a reasonable user fee paid to the IRS. Within 60 days, the IRS must acknowledge receipt of the notice of formation.
The new notice provision applies to all new Sec. 501(c)(4) organizations and to those who have not yet filed an annual information return as of Dec. 18, 2015.
Sec. 406 Declaratory Judgments
Sec. 501(c)(4) and other nonprofits may seek review in federal court for any revocation of exempt status by the IRS.
Sec. 408 No Gift Tax for Transfers to Sec. 501(c)(4) Organization
Previously, the IRS had suggested that it may audit taxpayers to determine whether transfers to Sec. 501(c)(4) organizations required filing IRS Form 709 and using the applicable gift exclusion amount or making payment of gift taxes. The PATH Act exempts transfers to Sec. 501(c)(4) organization from federal gift tax.
Applicable Federal Rate of 2.0% for December -- Rev. Rul. 2015-25; 2015-49 IRB 1 (20 Nov 2015)
The IRS has announced the Applicable Federal Rate (AFR) for December of 2015. The AFR under Section 7520 for the month of December will be 2.0%. The rates for November of 2.0% or October of 2.0% also may be used. The highest AFR is beneficial for charitable deductions of remainder interests. The lowest AFR is best for lead trusts and life estate reserved agreements. With a gift annuity, if the annuitant desires greater tax-free payments the lowest AFR is preferable. During 2015, pooled income funds in existence less than three tax years must use a 1.2% deemed rate of return. Federal rates are available by clicking here.
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