In the News

An Act That Makes This the Season for Giving

Tuesday, December 6, 2005
by John Authers and Christopher Swann



Only 25 days remain to take advantage of a give-away in the tax code for charitable givers. Ketra (the Katrina Emergency Tax-Relief Act), passed in the wake of the hurricane that devastated New Orleans and much of the Gulf Coast at the end of August, will expire on December 31. Its provisions double the maximum amount of charitable donations on which a taxpayer can claim tax relief - even if the charity has nothing to do with Katrina or the Gulf Coast.

Private banks, law firms and wealth managers have spent the last few weeks urging clients to revise their philanthropic plans for the year, while registered charities across the US have been urging people on their data-base to take advantage. Even People for the Ethical Treatment of Animals (Peta), whose worthy remit has little or nothing to do with hurricane relief, is telling its donors that Ketra is an "exciting opportunity".

But while there is agreement that the law Congress passed in September creates a huge philanthropic opportunity, the tight window of opportunity has createdconfusion. Some suggest it is worth realising gains in a portfolio, taking money out of a retirement account, or even taking out short-term loans, to take advantage of Ketra. Others suggest those strategies could backfire by opening donors to extra taxes elsewhere.

Taxpayers' deduction for all charitable contributions cannot usually exceed 50 per cent of their adjusted gross income for the year. For the relatively wealthy (in 2005, those who have more than Dollars 145,940 in adjusted gross income, or Dollars 79,975 for married taxpayers filing separately), their charitable deductions are also reduced by a "hair-cut" of 3 per cent.

Both provisions are eliminated under Ketra. Regardless of your gross income you can give 100 per cent of it to a public charity, all of which will be tax-deductible, providing the gifts have been made by December 31.

Some consultants suggest this year's increased exemptions are enough of an opportunity to justify taking gains - even though they would be subject to capital gains tax - and immediately donating the proceeds. The idea is that the additional income and gains can be off-set by the extra deduction.

PG Calc of Cambridge, Massachusetts, which provides back-up services for charitable fund-raisers, offers the example of a65-year-old with an income of Dollars 200,000 and more than Dollars 1m in a retirement fund who wants to give away Dollars 500,000. By withdrawing Dollars 500,000 from the account, he will increase his adjusted gross income to Dollars 700,000, and all of his Dollars 500,000 in donations will be tax-deductible.

There are risks involved with this. JP Morgan Private Bank, in its mailing to clients, cautions that "these strategies may produce unexpected surprises for the donor", because raising gross income could increase the 3 per cent haircut on other items "meaning the donor's tax bill might increase, even though the qualified contribution would be fully deductible". The bank says: "It could even prove economically beneficial to borrow money in the short term (if, for example, you expect a large cash bonus shortly after year-end) and use the cash to make a qualified donation."

How did a measure this generous, whose chief beneficiaries are those wealthy enough to consider giving away an entire year's income, find its way on to the statute book? It was passed when there was overwhelming political will to take some kind of action to limit the suffering caused by Hurricane Katrina.

There is also a justification for broadening tax relief beyond charities directly involved in the relief efforts. Joshua Kreitzer, a lawyer at the law offices of Marc Lane, a Chicago-based wealth consultancy, points out that that there was "real concern" among charities that Katrina would dent donations elsewhere in the charitable sector. A poll conducted by the charity database GuideStar found that, of more than 3,900 non-profit organisations surveyed,38 per cent expected contributions for the last quarter of 2005 to be down from last year because of disaster relief giving - while only4 per cent of organisations expected an increase in contributions.

Republicans in Congress said the sweeping tax relief was justified by the need to avoid perverse side effects for other charities.

Democrats said the proposals had met with little resistance. Of the broad range of tax breaks for the super-rich, the clauses on charitable giving are the least offensive to liberals. When the proposals were drafted they would have allowed rich individuals to donate money to private charitable trusts. But in its final form, the deduction is only available for donations to public charities. This means donors are less able to retain some control over the money.

Other points helped ensure Ketra could not be painted as a "tax loop-hole for the rich" - its provisions apply only to individuals, and not to companies, and donations must be made only in cash. Donations of securities or appreciated assets - a practice popular with wealth managers that functions as a way to minimise capital gains tax liability - are excluded.

Democrats saw the plans as a relatively innocuous extension of existing provisions. Even before the measures, wealthy individuals were allowed to carry over deductions for donations into subsequent years. Many Democrats believe the temporary break will make little difference.

The welter of activity from private banks and other advisors to the wealthy, as well as the concerted effort from charitable fund-raisers around the country to use Ketra to encourage donors into new giving, suggests they might be wrong.

Additional reporting by Christopher Swann in Washington

(c) 2005 The Financial Times Limited.


 


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