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Peter S. Hatinen

Peter S. Hatinen Trusts & Estates

phatinen@fredlaw.com
612.492.7319
Printable Version

Pension Protection Act of 2006

By: PETER S. HATINEN

May 2007

The Pension Protection Act of 2006 (the “PPA”) was signed into law on August 17, 2006. It contains many provisions that encourage retirement savings; makes permanent many of the most popular aspects of the Economic Growth and Tax Relief Reconciliation Act (“EGTRRA”) that were subject to sunset provisions; increases oversight of charitable contributions; and strictly regulates the activities of exempt organizations and their donors. Some highlights of the PPA are summarized below:

1.  Repeal of Sunset Provisions

EGTRRA contained numerous provisions related to retirement savings that were scheduled to expire in 2010 or 2011. Among others, the PPA makes the following important provisions permanent:

  • Increased contribution limits for IRAs;
  • Increased contribution limits for 401(k)s and employer contributions to qualified plans;
  • Increased benefit limits for qualified defined benefit plans;
  • 401(k) catch-up contributions for those age 50 and older; and
  • Provisions regarding section 529 plans.

2.  Rollovers to Non-Spouse Beneficiaries

Employer-sponsored 401(k) and other qualified plans, 403(b) plans, and 457 plans often mandate that benefits be paid to a beneficiary in a lump sum or within five years of a participant’s death. Under pre-PPA law, if the beneficiary was married to the participant, he or she was permitted to roll over the distribution to an IRA, but non-spouse beneficiaries (including beneficiaries of a trust) were not permitted the rollover option and often incurred substantial income tax liabilities. The PPA addresses this problem and permits non-spouse beneficiaries to transfer distributions received from a 401(k) or other qualified plan, 403(b) plan, or 457 plan directly to an “inherited” IRA. While the inherited IRA will remain subject to the minimum distribution requirements, a rollover permits the non-spouse beneficiary to defer income-tax liabilities over his or her life expectancy. (Note that for a non-spousal rollover to be effective, a trustee-to-trustee transfer must be made directly from the retirement-plan trustee to the IRA trustee or custodian, and the IRA receiving the rollover must be identified as an inherited IRA with respect to the deceased participant with the non-spouse beneficiary named as the beneficiary. In addition, the retirement plan document must permit the non-spousal IRA rollover.) 

3.  Charitable-Giving Incentives

The PPA permits individuals age 70½ and older to distribute up to $100,000 per year from traditional or Roth IRAs directly to charitable organizations—other than donor-advised funds, supporting organizations, private non-operating foundations, or charitable remainder trusts—without the contribution being included in gross income. This benefits taxpayers who are subject to the cap on annual charitable contribution deductions or to the phase-out of other itemized deductions based on adjusted-gross income, because the distributed funds are never included in the taxpayer’s income. The gift must be made directly from the IRA administrator to the charity. These provisions expire at the end of 2007.

4.  Charitable Donations—Substantiation and Limitations

The PPA imposes new requirements for certain donations made to charitable organizations. Donations of clothing and household items are no longer deductible unless the items are in “good” or better condition. Gifts made by cash or check are no longer deductible unless the donor substantiates the contribution with a cancelled check, bank record, or receipt indicating the name of the charity and the date and amount of the gift. Finally, deductions taken for contributions of tangible personal property are now subject to reduction or recapture if the charity disposes of the property within three years.

5.  Contributions of Fractional Interests in Tangible Personal Property

The PPA permits a charitable deduction for a contribution of a fractional interest in tangible personal property (such as artwork) to a charity, but only if it will be used in relation to the charity’s exempt purposes. The donor must relinquish his or her remaining interest in the property at death or 10 years from the date of the initial contribution, whichever is sooner. If the gift is not completed within the prescribed time, any deduction that has been taken will be recaptured and a 10 percent penalty assessed. Recapture will also take place if the charity fails to take “substantial physical possession” of the property or to use the property for an exempt purpose.

6.  Valuation Overstatements/Penalties for Appraisers

The PPA reduces the threshold for imposing penalties on tax payers for substantial and gross valuation misstatements. Under the new law, a substantial estate or gift-tax valuation misstatement exists when the claimed value of any property is 65 percent or less of the correct value. A gross misstatement exists when the claimed value of any property is 40 percent or less of the correct value. Moreover, a penalty may be imposed on individuals who prepare appraisals that contain substantial or gross-valuation misstatements. The penalty is equal to the greater of $1,000 or 10 percent of the understatement of tax resulting from the misstatement, up to a maximum of 125 percent of the gross income derived from the appraisal. This penalty will not be imposed if the appraiser can establish that it is “more likely than not” that the appraisal reflected the correct value of the property in question.

7.  Regulation of Exempt Organizations

Organizations currently not required to file Form 990 because their gross annual receipts do not exceed $25,000 must now submit an annual electronic return with basic organizational information including the name under which the organization does business, internet and mailing addresses, and the identity of its principal officer. The return will be available to the public. Failure to file the return for three consecutive years will result in the revocation of tax-exempt status.

8.  Regulation of Private Foundations

The excise taxes applicable to private foundations (IRC sections 4940-4945) are generally doubled. Thus, the PPA increases the tax for self-dealing from 5 percent to 10 percent for the self-dealer and from 2.5 percent to 5 percent for the foundation managers, and increases the maximum tax imposed on foundation managers from $10,000 to $20,000 for each act of self-dealing.

The PPA increases the maximum tax imposed on foundation managers for participating in excess benefit transactions from $10,000 to $20,000, per transaction.

For failure to distribute income, the PPA increases the tax on the foundation from 15 percent to 30 percent of the undistributed amount.

For excess business holdings, the PPA increases the tax from 5 percent to 10 percent of the value of the excess business holdings.

For jeopardizing investments, the PPA doubles the tax on the foundation and its managers from 5 percent to 10 percent of the amount of the investment, increases the maximum tax imposed on foundation managers from $5,000 to $10,000 per investment, and increases the maximum additional tax imposed on foundation managers from $10,000 to $20,000.

For taxable expenditures, the PPA increases the initial tax on the foundation from 10 percent to 20 percent of the expenditure, the initial tax on the foundation managers from 2.5 percent to 5 percent of the expenditure, the maximum amount of the initial tax imposed on the foundation mangers from $5,000 to $10,000, and the maximum amount of any additional tax imposed on the foundation managers from $10,000 to $20,000.

The PPA also provides that private non-operating foundations may not count as qualifying distributions contributions to (i) Type III supporting organizations that are not “functionally integrated” (see discussion below) or (ii) any other supporting organization if a disqualified person directly or indirectly controls the supporting organization or any supported organizations.

9.  Regulation of Donor-Advised Funds

The PPA introduces a new excise tax that applies to donor-advised funds. The PPA imposes on the organization that manages a donor-advised fund a 20 percent tax on any “taxable distribution.” Managers are also subject to a 5 percent tax, up to $10,000, for any taxable distribution. A taxable distribution is defined as a grant to an individual or any entity for a non-charitable purpose. A distribution to a public charity (other than certain supporting organizations) or a private operating foundation is not taxable. Distributions to certain other types of organizations require the organization that manages the donor-advised fund to exercise expenditure responsibility over the distribution for it to avoid being considered a taxable distribution.

The PPA extends the excess-benefit-transaction rules to donor-advised funds by defining donors, donor advisors, and persons related to them as disqualified persons. Grants, loans, compensation, and similar payments from donor-advised funds to disqualified persons are treated as automatic-excess-benefit transactions, and the entire amount of the transaction will be subject to excess-benefit-transaction excise taxes.

The PPA provides that if a donor, advisor, family member of a donor or advisor, or any entity controlled by them receives more than an “incidental benefit” from a grant, a penalty of 125 percent of the amount may be imposed on the person who recommended the grant and the benefited party. Managers who approved the grant knowing it would result in the benefit are also subject to a penalty of 10 percent of the grant.

The PPA applies the excess-business holding rules that apply to private foundations to donor- advised funds.

The PPA provides that donors may claim deductions for contributions to donor-advised funds only if they receive a written acknowledgement from the organization managing the fund that it has exclusive legal control over the contributed assets. The deduction is denied for contributions made to donor-advised funds that are managed by certain Type III supporting organizations.

10.  Regulation of Supporting Organizations

The PPA applies the excess-benefit-transaction rules to supporting organizations. Any grant, loan, compensation, or similar payment from a supporting organization to a substantial contributor, member of the contributor’s family, or business controlled by such persons is treated as an automatic-excess-benefit transaction and the entire amount is subject to the excise tax.

The PPA requires all supporting organizations to file annual Form 990s indicating whether they are Type I, II, or III supporting organizations, identifying the organizations they support, and certifying that they are not controlled by disqualified persons.

The PPA requires the Secretary of the Treasury to promulgate new regulations imposing minimum-payout requirements for Type III supporting organizations that are not “functionally integrated.” A Type III supporting organization is not functionally integrated if it is not required to make payments to supported organizations because it satisfies the integral-part test by performing activities that, but for the existence of the supporting organization, would be carried out by the supported organizations.

The PPA applies the excess-business-holding rules to Type III supporting organizations that are not functionally integrated and to certain Type II supporting organizations.

The PPA prohibits Type III supporting organizations from supporting foreign charities.

Finally, the PPA provides that a supporting organization will fail to qualify as a Type I or Type III supporting organization if it accepts contributions from a person who directly or indirectly controls a supported organization, a family member of such a person, or an entity controlled by such persons.