United States: New Tax Law Provides Incentives for Charitable Giving

In response to the devastation caused by Hurricane Katrina and the outpouring of aid by American taxpayers in its aftermath, Congress recently adopted the Katrina Emergency Tax Relief Act of 2005 (Katrina Act), which President Bush signed into law on September 23, 2005. The Katrina Act contains a number of provisions that ease the tax burden for those directly affected by Hurricane Katrina, but also creates significant incentives for all taxpayers to increase charitable giving.

Generally, taxpayers are permitted to deduct contributions for charitable purposes subject to certain limitations based on whether the taxpayer is an individual or corporation, the type or amount of property contributed and the tax characterization of the donee organization. The Katrina Act suspends these limitations for certain contributions made before year-end.

For individual taxpayers, cash contributions made during the period from August 28, 2005 through December 31, 2005 to any 501(c)(3) public charity (other than supporting organizations and donor-advised funds) and certain private foundations (qualified contributions) will be treated as "above-the-line" deductions. This means that qualified contributions by individual taxpayers will not be subject to reduction if the taxpayer’s adjusted gross income exceeds a threshold amount (which was $142,700 in 2004 for most taxpayers). Further, the Katrina Act allows an individual taxpayer to deduct charitable contributions in an amount up to 100 percent of the taxpayer’s contribution base (generally, adjusted gross income) as opposed to 50 percent of the contribution base under current law. An individual taxpayer may deduct qualified contributions in an amount equal to the excess of the taxpayer’s contribution base over the amount of other charitable contributions made by the taxpayer. Excess deductions for qualified contributions may be carried forward and deducted over the succeeding five years.

Under current law, corporations are permitted to deduct charitable contributions in an amount up to 10 percent of the corporation’s taxable income (less certain loss carrybacks). This 10 percent limitation is suspended for qualified contributions provided they are for relief efforts related to Hurricane Katrina. This requirement does not apply to individual taxpayers. Corporate taxpayers will be required to substantiate that the contribution is made for this purpose. Corporate taxpayers may deduct qualified contributions used for Hurricane Katrina relief in an amount equal to the excess of the corporation’s taxable income over the corporation’s deductions for other charitable contributions. Any excess deductions may be carried forward and deducted over the succeeding five years. Again, an election must be made to qualify for this treatment.

In addition to suspending limitations for charitable contributions, the Katrina Act also allows taxpayers who provide rent-free housing to individuals displaced by Hurricane Katrina to claim additional personal exemptions. Under the Katrina Act, an individual taxpayer may claim an additional $500 personal exemption for each displaced individual to whom the taxpayer provides rent-free housing in the taxpayer’s principal residence, up to $2,000. A "displaced individual" for purposes of this additional exemption is a person whose principal place of abode on August 28, 2005 was in the Hurricane Katrina disaster area, who was displaced from that abode and who is provided housing free of charge in the taxpayer’s principal residence for a period of 60 consecutive days which ends in the taxable year in which the exemption is claimed. A displaced person cannot be a spouse or dependent of the taxpayer. A taxpayer may claim this exemption for any one displaced individual only one time for all taxable years.

The Katrina Act also increases the charitable mileage deduction for a taxpayer’s vehicle use to provide relief related to Hurricane Katrina. Under this provision, the charitable mileage deduction rate increases to 70 percent of the business mileage rate in effect on the date of contribution rather than the charitable standard mileage rate of 14 cents per mile. In addition, amounts reimbursed to volunteers by charitable organizations for the cost of using passenger automobiles for the benefit of the organization in connection with providing Hurricane Katrina relief is excluded from gross income.

The Katrina Act also extends to all businesses an enhanced deduction for donations of food inventory that currently applies only to C corporations. Under the Katrina Act, all businesses may take a deduction for contributions of food inventories made before the end of the year up to an amount equal to an "augmented basis" (the lesser of basis plus one-half of the item’s appreciation, or two times basis). For taxpayers other than C corporations, the total deduction for donations of food inventory in a taxable year may not exceed 10 percent of the taxpayer’s aggregate net income for that taxable year from all businesses of the taxpayer from which contributions of food are made.

The Katrina Act also provides that C corporations contributing book inventories to public schools may deduct those contributions using the "augmented basis" described above.

These new provisions relating to contributions of food and books are similar to, and in addition to, the existing enhanced charitable contribution deductions for contributions of certain inventory by corporations under Section 170(e)(3) of the Internal Revenue Code (Code).

The new charitable giving incentives of the Katrina Act complement Section 139 of the Code, which was enacted shortly after 9/11 and which allows employers to provide tax-free assistance to employee victims of disasters under certain circumstances. Also, prior to adoption of the Katrina Act, the IRS issued Notice 2005-68, which increases the favorable tax effect of leave-based donation programs under which employees forgo vacation, sick or personal leave in exchange for employer contributions to charitable organizations and hurricane relief funds. For more information on Notice 2005-68 and leave donation programs,please click on 'next page' at the bottom of this article.

In addition to creating incentives for charitable giving, the Katrina Act provides tax relief for those directly affected by Hurricane Katrina, including relief from penalties for early withdrawals from retirement funds, increased deductibility of non-business casualty losses and other tax incentives.

PRACTICE NOTE: Many of the tax incentives provided by the Katrina Act are specific to relief efforts related to Hurricane Katrina. Obviously, when the U.S. Congress adopted the Katrina Act, it did not anticipate Hurricane Rita. It is possible that Congress may pass similar charitable giving incentives for relief efforts related to Hurricane Rita or apply Katrina Act provisions to victims of Hurricane Rita.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.