2005 Lane Reports

Tax Relief Opportunities Have Been Created in Reaction to Hurricane

Thursday, December 1, 2005
by Joshua S. Kreitzer, J.D.

Individuals with a mind toward making charitable contributions to reduce their tax liability should be aware that Congress has made increased tax deductions available for the rest of the year 2005 only - and, depending on your income and the charitable contributions you are making, your potential tax deductions could be much higher than usual this year.

The new tax opportunities were established in reaction to Hurricane Katrina. Although the disaster prompted an outpouring of charitable contributions to provide relief to victims in Louisiana and other affected areas, the charitable needs of the rest of the nation continue to require fulfillment as well. Therefore, Congress chose to suspend limitations on charitable deductions to all public charities - not just those that assist hurricane victims - with the Katrina Emergency Tax Relief Act of 2005 ("KETRA"). Senator Chuck Grassley of Iowa explained this provision, stating, "[O]ur goal is to encourage charitable giving outside of Katrina relief to prevent the rest of the nation's charities from seeing a downturn in giving as they did after Sept. 11." For many charities, this is a real concern. A poll conducted by the charity database GuideStar found that, of more than 3,900 nonprofit organizations surveyed, 38% expected contributions for the last quarter of 2005 to be down from last year because of disaster relief giving - while only 4% of organizations expected an increase in contributions.

To understand the relief afforded by KETRA, it is helpful to review the tax deduction rules in effect prior to the enactment of KETRA. Normally, these particular rules would affect only those taxpayers whose total charitable contributions for the year are at least 20% of their adjusted gross income - a relatively small group. The following rules apply in most years:

1. A taxpayer's deduction for all charitable contributions cannot exceed 50% of the taxpayer's adjusted gross income for the year.

2. A taxpayer's deduction for charitable contributions to certain organizations cannot exceed 30% of the taxpayer's adjusted gross income.

3. Charitable organizations, contributions to which are only subject to the 50% limit, are referred to as "50% limit organizations." These organizations are a broad group, including churches, schools, hospitals, governments (the United States, its states and possessions, political subdivisions such as cities and counties, and Indian tribal governments), and many other charitable organizations which are considered "publicly supported" because they receive substantial support directly or indirectly from contributions from the general public or governmental units (as opposed to being supported by one person or a small group of supporters), or which are considered to meet the needs of the general public as opposed to a limited number of donors or other persons.

4. The 30% limit applies to contributions to other organizations such as veterans' organizations, fraternal societies, nonprofit cemeteries, and certain private nonoperating foundations, and gifts "for the use of" any organization.

In addition, another limitation normally applies to upper-income taxpayers - in 2005, those who have over $145,940 in adjusted gross income ($79,975 for married taxpayers filing separately). For those taxpayers, their charitable deduction is normally reduced by 3%.

However, under KETRA, individual taxpayers who make donations to any "50% limit organization" between August 28 and December 31, 2005, are allowed to deduct such contributions up to 100% of their adjusted gross income. Furthermore, such contributions will not be subject to the 3% reduction.

If a partnership or a Subchapter S corporation makes charitable contributions during the period from August 28 to December 31, those contributions will pass through to the partners or shareholders who may elect to have similar tax treatment applied to such contributions.

For Subchapter C corporations, which pay taxes in their own right, the deduction for charitable contributions is normally limited to 10% of their taxable income (less other contributions). KETRA has removed this limit for contributions to 50% limit organizations made by corporations between August 28 and December 31, 2005 - but only to the extent that those contributions are for relief efforts related to Hurricane Katrina.

KETRA also provides other types of tax relief as well. For example, a taxpayer who takes or has taken a "Hurricane Katrina displaced individual" into his or her home for a period of at least 60 days will receive a tax exemption of $500 for each such displaced individual, up to a maximum of four people ($2,000). To qualify for this exemption, the displaced person must have had his or her principal place of abode in the Hurricane Katrina disaster area as of August 28, 2005, and been displaced from that abode. (If the displaced person lived outside the core disaster area, the person's home must have been damaged by the hurricane or the person must have been evacuated from their home because of the hurricane.) Also, the taxpayer must have provided free housing to the displaced person in the taxpayer's own principal residence for a period of at least 60 consecutive days. (The taxpayer's spouse or dependent cannot qualify as a displaced person.) If the 60-day period ended in 2005, the taxpayer can claim the exemption for 2005, and if the 60-day period ends in 2006, the taxpayer can claim the exemption for 2006. The exemption will not be available for tax years after 2006.

Other forms of relief provided by KETRA are intended to help hurricane victims use retirement funds to get themselves back on their feet. For example, normally a 10% additional tax applies to distributions from retirement plans before a taxpayer reaches age 59 ˝. However, this tax will not be applied to any distribution from an eligible retirement plan made between August 25, 2005 and December 31, 2006 to an individual whose principal place of abode as of August 28, 2005 was located in the Hurricane Katrina disaster area and who suffered an economic loss from the hurricane - up to $100,000. Furthermore, such a "qualified Hurricane Katrina distribution" will be included in the taxpayer's gross income over a 3-year period (rather than all at once, in the year of the distribution) unless the taxpayer specifically elects otherwise. Finally, if a taxpayer from the disaster area takes such a qualified Hurricane Katrina distribution, he or she may repay the distribution to a retirement plan which accepts rollover contributions (such as an IRA) within 3 years of the distribution.

Similarly, retirement plan loans from qualified employer plans are normally limited to the lesser of $50,000 or one-half of the participant's vested benefits in the plan. However, KETRA provides that if a participant had his or her principal place of abode in the Hurricane Katrina disaster area as of August 28, 2005, and sustained an economic loss because of the hurricane, the participant may borrow up to the lesser of $100,000 or the full value of his or her vested benefits in the plan. Such loans may be taken at any time between the date KETRA was enacted (September 23, 2005) and December 31, 2006. Furthermore, if such a participant had outstanding loans from a qualified employer plan on or after August 25, 2005, the participant may delay making repayments which would otherwise come due between that date and December 31, 2006 by up to one year.

If you have been affected by Hurricane Katrina and wish to find out more about the tax relief offered to you by KETRA - or you live elsewhere and want advice about increasing your charitable contributions to take advantage of the increased deductions - please let us know.

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Joshua S. Kreitzer (B.A., Harvard University; M.A., University of South Florida; and J.D., Northwestern University) is an Associate Attorney with The Law Offices of Marc J. Lane, a Professional Corporation.

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The Lane Report is a publication of The Law Offices of Marc J. Lane, a Professional Corporation. We attempt to highlight and discuss areas of general interest that may result in planning opportunities. Nothing contained in The Lane Report should be construed as legal advice or a legal opinion. Consultation with a professional is recommended before implementing any of the ideas discussed herein. Copyright © 2007 by The Law Offices of Marc J. Lane, A Professional Corporation. Reproduction, in whole or in part, is forbidden without prior written permission.

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