The Katrina Emergency Tax Relief Act of 2005
October 2005
The Katrina Emergency Tax Relief Act of 2005 (KETRA) was signed into law on September 23, 2005. KETRA contains two important federal income tax incentives for charitable giving that offer substantial planning opportunities for charitably inclined taxpayers. First, KETRA increases the limit on individual income tax deductions for contributions of cash to most public charities. Second, KETRA suspends the scaling down of the charitable deduction for taxpayers whose income exceeds specified thresholds. KETRA applies to contributions made from August 28 to December 31, 2005 and does not require that such charitable contributions be made for the purpose of Hurricane Katrina relief.
Pre-KETRA Law
In general, taxpayers are permitted an income tax deduction for charitable contributions, subject to limits that are calculated as a percentage of the taxpayer’s Adjusted Gross Income (AGI). This percentage varies based upon the donee and the property that is contributed. Contributions of cash to public charities are generally deductible to the extent of 50% of the taxpayer’s AGI. Excess charitable contributions may generally be carried forward and deducted over a five-year period. For 2005, a taxpayer’s itemized deductions (including charitable contribution deductions) are scaled down by 3% of the amount of the taxpayer’s AGI in excess of $145,950 (or $72,975 for married taxpayers filing separate returns). The total amount of the disallowed itemized deductions cannot exceed 80% of the otherwise allowable itemized deductions.
KETRA
Increased Limits on Cash Gifts
KETRA permits individual taxpayers to deduct “qualified contributions” up to the amount by which his or her AGI exceeds his or her deductions for other charitable contributions. The practical effect of the increased limits on cash gifts is to permit an individual taxpayer to deduct cash contributions to most public charities in an amount equal to 100% of his or her AGI for the balance of 2005. Contributions in excess of this amount may be carried forward for five years as contributions to which the 50% limitation applies. Qualified contributions are contributions of cash made to most public charities from August 28, 2005 to December 31, 2005. They do not include contributions to establish new or to maintain existing segregated funds or accounts over which the donor has or expects to have advisory privileges with respect to distributions or investments (for example, donor advised funds). Contributions need not be limited to Hurricane Katrina relief to be considered qualified contributions.
Suspension of Itemized Deduction Limitations
KETRA also temporarily suspends the scaling back of the charitable deduction for qualified contributions made by taxpayers whose income exceeds specified thresholds. Under KETRA, individual taxpayers receive a dollar-for-dollar deduction for all qualified contributions, but all other itemized deductions remain subject to the 3% scaledown.
Indirect IRA Rollovers
Tax practitioners have identified in KETRA provisions which appear to facilitate the indirect charitable rollover of IRA assets. KETRA permits a taxpayer to make qualified contributions to public charities and to deduct such contributions up to an amount equal to 100% of his or her AGI through the end of 2005. Distributions from IRAs are generally included in an individual’s AGI. Therefore, if a donor makes a withdrawal from an IRA, such withdrawal will increase his or her AGI and his or her ability to deduct qualified contributions made with such assets on a dollar-for-dollar basis.
Unfortunately, KETRA does not remove all of the tax costs associated with making IRA withdrawals. If a taxpayer is under 59 ½ years old, any withdrawal is treated as an early withdrawal and subject to a 10% tax. Indirect charitable rollovers of IRAs also illustrate the limited relief offered under KETRA. While KETRA permits the full deduction of qualified contributions, it does not protect other itemized deductions (such as deductions for state and local taxes and mortgage interest). Thus, while withdrawing proceeds from an IRA increases an taxpayer’s AGI and subsequently the charitable deduction available to him or her, it also reduces a taxpayer’s other itemized deductions by increasing his or her AGI. Therefore, before a taxpayer decides to make an indirect charitable rollover of IRA assets, he or she must assess his or her tax situation and determine whether the increased charitable deduction is worth the early withdrawal taxes that may be incurred or the other deductions that may be lost.
Conclusion
KETRA contains important federal income tax incentives for taxpayers
who are charitably inclined. Most importantly, it significantly increases
the limit on cash contributions to public charities by permitting a taxpayer
to deduct cash contributions to most public charities equal to 100% of
his or her AGI for the balance of 2005. KETRA also appears to facilitate
the indirect rollover of IRA assets to public charities, though doing
so may not be without some tax cost. Given the complexity of KETRA’s
interaction with the tax code, taxpayers should consult their tax advisors
when considering whether or not to take advantage of the charitable contribution
incentives contained KETRA.
*Required IRS Disclosure: To ensure compliance with requirements imposed by the IRS, we inform you that any U.S. tax advice contained in this communication is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code, or (ii) promoting, marketing, or recommending to another party any matters addressed herein.*