The Katrina Emergency Tax Relief Act that President Bush signed Sept. 23 included some substantial changes to the legislation initially proposed. What survived the chopping block, what crept in the back door, and what does it all mean for charitable giving?
The act temporarily suspended the percentage limitations for cash contributions to public charities made by individuals from Aug. 28 through Dec. 31. Draft bills had required that contributions be related to Katrina relief efforts. But the final law applies this restriction only to corporate contributions.
What's the rationale behind allowing an individual donor to give $100,000 in cash to his alma mater before Dec. 31, without being subject to the usual percentage limitation?
In part, Congress was worried about a possible Sept. 11 effect, whereby donors would generously contribute to tragedy-related charities, leaving other charities, like food banks and homeless shelters in other areas of the country, floundering for dollars.
But was a tax break really necessary? Maybe — but not for the reasons Congress had in mind.
Spurred by news reports in late September and October 2001 describing a sharp drop in donations to non-profits unrelated to Sept. 11, two U.S. senators proposed tax-relief legislation intended to encourage giving to other charities. Even though this legislation never passed, most charities discovered that year-end tallies were better than expected. Giving USA, the leading annual source of information on charitable giving in the United States, reported in 2002 that overall giving for 2001 fell by only 2.3 percent, and that contributions to charities related to Sept. 11 ($1.9 billion) were less than 1 percent of the total raised by charities nationwide. In other words, there was no significant Sept. 11 effect on charitable giving.
But if history is any indicator, what is more likely to put a damper on 2005 year-end giving is the economy. The Congressional Budget Office reported a budget deficit of $317 billion in the fiscal year that ended on Sept. 30. Analysts expect this figure to balloon in the coming year, in large part from the costs of post-hurricane reconstruction. Charities potentially face losses similar to declines reported by Giving USA after the 1973 oil embargo (a 10.9 percent drop in giving) and the 1987 stock market crash (a 15.6 percent drop). Such losses are unlikely to be fully offset by Katrina Act-inspired donations.
STATE INCOME TAXES
There's another counterweight to a sudden splurge in year-end giving: state income taxes. Although a taxpayer could conceivably eliminate all of his adjusted gross income and pay no federal income tax in 2005 by making cash charitable gifts under the Katrina Act to match his adjusted gross income (AGI), he may still owe state income tax. Some states, such as Connecticut and Massachusetts, base their tax on federal AGI, before deductions are accounted for, and other states may have lower ceilings on deductibility for charitable gifts.
Also, despite the federal tax break, there are not likely to be a lot of people pulling money out of their individual retirement accounts to donate to charity before the end of the year. The Katrina Act does not provide an indirect IRA charitable rollover.
During the past several years, a number of legislative proposals, including the just-reintroduced CARE Act, have included an IRA charitable rollover provision. If passed into law, taxpayers age 70 1/2 and older would be allowed to roll over amounts from their IRA accounts directly to charity, tax free. Taxpayers 59 1/2 and older could transfer IRA funds tax free to charitable remainder unitrusts, annuity trusts, pooled income funds and gift annuities. Although originally included in the Katrina Relief Act, it was eliminated at the last minute.
Nevertheless, some commentators initially speculated that the waiver of the 50 percent charitable gift deduction limitation could produce the same result for taxpayers over age 59 1/2, who avoid the 10 percent early-withdrawal penalty. For example, if a 60 year old taxpayer withdraws $25,000 from his IRA, his AGI increases by $25,000. If he then makes a cash gift of that amount by Dec. 31 to a public charity, he receives an offsetting deduction, resulting in a wash. But, because he increased his 2005 AGI by $25,000, many other tax benefits may be reduced, such as the deductions for mortgage interest, local and state taxes, medical expenses and casualty losses. There also may be alternative minimum tax implications.
Cashing out an IRA to make a charitable gift is another area where state laws governing the taxation of IRA withdrawals and charitable contributions could produce unforeseen state tax results — added state income taxes — and, thus, unhappy donors.
FIRST, DO NO HARM
The complexity of our tax laws makes the job of providing effective financial assistance to victims of tragedy under our tax laws no small task. We must be sure to read the fine print, and between the lines, and do the arithmetic for each client to make certain that there is no harm in doing good.