Pension Reform Bill Containing Charitable Provisions Signed into Law

On August 17, 2006, President Bush signed the Pension Protection Act of 2006 into law. The bill, H.R. 4, was passed by Congress on August 3, 2006, and includes many provisions that pertain to charitable organizations and charitable giving. Those provisions are briefly summarized below. More detailed information is available upon request.

1. Tax Free IRA Distributions to Charities. This provision allows individuals who are at least 70 ½ years of age to annually distribute up to $100,000 of their IRA or Roth IRA balance to charitable organizations during 2006 and 2007 without recognizing the donation as taxable income, and without taking a charitable deduction. This distribution would count towards the required minimum distribution imposed upon IRA owners over age 70 ½.
2. Tax Treatment of Certain Payments to Controlling Exempt Organizations. This provision amends section 512(b)(13) of the Internal Revenue Code ("IRC") and alters the tax treatment of certain payments received by exempt organizations from controlled entities. An entity is controlled if the exempt organization owns over 50% of its stock; profits interest or capital interest; or beneficial interests. Previously, interest, annuities, royalties, or rents (but not dividends) received by an exempt organization from a controlled entity were taxable as unrelated business taxable income ("UBTI") to the extent such payments either reduced the controlled entity’s net unrelated income or increased its net unrelated loss. Under the Pension Protection Act of 2006, such payments received by an exempt organization during 2006, 2007, or 2008 from a controlled entity will only be included in the calculation of the exempt organization’s UBTI to the extent that the payments exceed a comparable fair market value payment, as determined using the principles of IRC § 482.¹
3. Contributions of Real Property for Conservation Purposes. This provision allows donors to take charitable deductions of up to 50% of their contribution base for contributions of qualified conservation real property. Qualified farmers and ranchers may take charitable deductions of up to 100% of their contribution base for such contributions. Corporations which qualify as farmers and ranchers may take charitable deductions of up to 100% of taxable income in certain cases. This provision is effective for contributions made in 2006 and 2007.

The Pension Protection Act includes several provisions which are intended to improve regulation of exempt organizations, including:

1. Excise Taxes Increased. Excise taxes imposed on private foundations, public charities, and social welfare organizations are increased effective for taxable years beginning after August 17, 2006, as follows:
1. Self-Dealing. The initial excise tax imposed under IRC § 4941(a) upon self-dealers is doubled from 5% to 10%, and the initial excise tax imposed upon foundation managers for self-dealing transactions is doubled from 2.5% to 5%. Moreover, the dollar limitation on the amount of excise tax imposed on foundation managers per act of self-dealing is doubled from $10,000 to $20,000 per act under IRC § 4941(c)(2).
2. Failure to Distribute Income. The initial excise tax imposed on private foundations for failure to satisfy the annual distribution amount under IRC § 4942(a) is doubled from 15% to 30% of the undistributed amount.
3. Excess Business Holdings. The initial excise tax imposed on private foundations under IRC § 4943(a) on excess business holdings is doubled from 5% to 10% of the value of such holdings.
4. Jeopardizing Investments. The initial excise tax imposed on private foundations and on foundation managers under IRC § 4944(a) on jeopardizing investments is doubled from 5% to 10% of the amount of the investment. Additionally, the dollar limitation on the initial tax on foundation managers is doubled from $5,000 to $10,000 per jeopardizing investment. The dollar limitation on the additional tax on foundation managers is doubled from $10,000 to $20,000 per jeopardizing investment.
5. Taxable Expenditures. The initial excise tax imposed on private foundations under IRC § 4945(a) on taxable expenditures is doubled from 10% to 20% of the amount of the expenditure. The initial excise tax imposed on foundation managers is doubled from 2.5% to 5% of the amount of the taxable expenditure. The dollar limitation on the initial tax on foundation managers is doubled from $10,000 to $20,000, and the dollar limitation on the additional tax on foundation managers is doubled from $10,000 to $20,000.
6. Excess Benefit Transactions. The dollar limitation on managers of public charities and social welfare organizations that participate in excess benefit transactions prohibited under IRC § 4958 is doubled from $10,000 to $20,000.
2. Recapture of Tax Benefit on Charitable Property Not Used for an Exempt Use. A donor is prohibited from taking a charitable deduction that is greater than the basis of any appreciated tangible personal property donated to a charitable organization, if the charitable organization then disposes of the property within three years of its receipt. If the recipient charitable organization provides a certification that the property was intended to be used or was put to a use related to the organization’s exempt purpose, the donor’s charitable deduction is not limited to the basis of the property.
3. Additional Standards for Credit Counseling Organizations. IRC §§ 501 and 513 are amended with additional standards that must be met by credit counseling organizations determined to be exempt from federal income tax as organizations described in IRC §§ 501(c)(3) and 501(c)(4). Specifically, such organizations must tailor credit counseling services to the specific needs and circumstances of consumers; may not make loans to debtors, or negotiate loans on their behalf; may provide credit improvement services only if such services are incidental to the provision of credit counseling services (although a separately-stated fee for such improvement services may not be charged); may not refuse to provide credit counseling services due to an inability to pay, ineligibility for debt management plan enrollment, or unwillingness to enroll in a debt management plan; must establish and implement a reasonable fee policy; must have an independent governing body controlled by persons who represent the broad interests of the public; may not own more than 35% of a corporation, partnership, estate, or trust in the trade or business of lending money, repairing credit, or providing debt management plan services, payment processing, or similar services, unless such corporation, partnership, estate, or trust is determined to be described in IRC § 501(c)(3); and may receive no amount for providing referrals to others for debt management plan services, and pay no amount to others for obtaining referrals of consumers. A § 501(c)(3) credit counseling organization must also satisfy a new "aggregate revenues requirement". These provisions are effective for credit counseling organizations currently described in IRC §§ 501(c)(3) or 501(c)(4) for taxable years beginning after August 17, 2007.
4. Expansion of Base of Tax on Net Investment Income for Private Foundations. This provision expands the base upon which the 2% excise tax imposed on the net investment income of private foundations under IRC § 4940 is calculated to include income from sources similar to interest, dividends, rents, payments with respect to securities loans, and royalties. Additionally, the definition of "capital gain net income" in IRC § 4940(c)(4)(A) is modified such that gain or loss from a sale or disposition of property is included in capital gain net income if the property is used for the production of gross investment income.
5. Notification Requirements for Exempt Organizations Not Currently Required to File Annual Returns. Exempt organizations which are not currently required to file annual returns because they have annual gross receipts that do not normally exceed $25,000 instead are now required to file an annual notification with the IRS. Failure to file an annual return or the required annual notification for three consecutive years will result in revocation of tax-exempt status. Any organization whose tax-exempt status has been revoked must apply for reinstatement, even if no such application was originally required for the organization.
6. Disclosure to State Officials Relating to Exempt Organizations. Information relating to proposed IRS actions regarding organizations described in IRC § 501(c)(3), or organizations that have applied for recognition as organizations described in IRC § 501(c)(3), may be disclosed to state officials upon written request. Specifically, the IRS may disclose to state officials a notice of proposed refusal to recognize an organization as described in IRC § 501(c)(3); a notice of proposed revocation of the organization’s taxexempt status; the issuance of a letter of proposed deficiency of tax imposed under IRC § 507 or chapters 41 and 42 of the IRC; and the names, addresses, and taxpayer identification numbers of organizations that have applied for recognition as organizations described in IRC § 501(c)(3). This is effective on August 17, 2006, but does not apply to requests made before that date.
7. Public Disclosure of Information Relating to Unrelated Business Income Tax Returns. Organizations described in IRC § 501(c)(3) are now required to make available for public inspection information found on IRS Form 990-T, Exempt Organization Business Income Tax Return, unless the disclosure would adversely affect the organization, such as a trade secret, patent, etc.
8. Study on Donor Advised Funds and Supporting Organizations. The Secretary of the Treasury is directed to conduct a study on the organization and operation of donor advised funds and supporting organizations, which must consider whether charitable deductions allowed for donations to such organizations are appropriate given the use of contributed assets, and the use of the assets for the benefit of the donor; whether donor advised funds should be subject to required distribution limits; whether the retention of rights and privileges by donors with respect to contributions is consistent with the treatment of such contributions as completed gifts for the purpose of income, gift, and estate tax deductions; and whether these issues also pertain to other types of charities. The report is due to Congress by August 17, 2007.
9. Excise Taxes Relating to Taxable Distributions from Donor Advised Funds. An excise tax is imposed on sponsoring organizations which is equal to 20% of any taxable distribution from donor advised funds. Also, an excise tax of 5% of any taxable distribution from donor advised funds is imposed on any fund manager that knowingly agreed to make the distribution. A $10,000 limit is imposed on fund management for each taxable distribution. "Taxable distribution" is defined as any distribution from a donor advised fund to a natural person, or to any other person if (1) the distribution is for any nonexempt purpose, or (2) if the sponsoring organization does not exercise expenditure responsibility with respect to such distributions. The excess business holdings rules of IRC § 4943 are now applicable to donor advised funds. Also, a 125% penalty tax will be imposed if the donor, advisor, or related parties receive more than an incidental benefit from a donor-advised grant.
10. Improved Accountability Requirements for Supporting Organizations. A new statutory definition of "supported organization" describes the three alternative types of supporting organizations, and imposes new requirements on supporting organizations. In particular, Type III supporting organizations will not be considered to operate in connection with a qualified organization unless (1) the supporting organization provides an annual report to each supported organization, and (2) the supporting organization is not operated in connection with any foreign supported organization. Supporting organizations which currently operate in connection with any foreign supported organization are subject to a three year transition rule which delays the imposition of this provision to the first day of the third taxable year following the enactment of this law. An organization will not qualify as a Type I or Type III supporting organization if it accepts a gift from a donor who controls, either directly or indirectly, a supported organization. The IRS is authorized to promulgate regulations regarding annual distribution requirements for Type III supporting organizations which are not functionally integrated Type III supporting organizations. Such regulations will require these organizations to make distributions of a percentage of either income or assets to their supported organizations. These provisions are effective beginning August 17, 2006.
11. Automatic Excess Benefit Transactions of Supporting Organizations. The definitions of "excess benefit", "excess benefit transaction" and "disqualified person" are expanded under IRC § 4958 specifically as they pertain to supporting organizations. In particular, any payment of a grant, loan, compensation, or similar payment by a supporting organization (Type I, Type II, or Type III) to a substantial contributor, a member of his or her family, or a 35% controlled entity, is treated automatically as an excess benefit transaction with the entire amount of the payment treated as the excess benefit. In addition, loans by any supporting organization to a disqualified person of the supporting organization, as defined in IRC § 4958, are treated as excess benefit transactions, and the entire amount of the loan is considered to be the excess benefit.
12. Excess Business Holdings of Supporting Organizations. The excess business holding rules which apply to private foundations are extended to certain Type II and Type III supporting organizations.
13. Grants from Private Foundations to Supporting Organizations. The definition of "qualifying distribution" under IRC § 4942 is modified so that payments made by a private foundation to (1) a Type III supporting organization that is not a functionally integrated Type III supporting organization, or (2) any other supporting organization, if a disqualified person with respect to the private foundation controls the supporting organization or a supported organization of such supporting organization, will not constitute qualifying distributions. Any such payments will be treated as taxable expenditures, unless expenditure responsibility is exercised. This provision is effective August 17, 2006.

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.