The Katrina Relief Act: A special article

On September 23, 2005, the President signed the Katrina Emergency Tax Relief Act of 2005 (KETRA). The Act does a lot to promote giving to those organizations that are directly involved in relief, but I am going to focus on those provisions that promote giving to all non-profits.

As the end of the tax year approaches, explaining these incentives to your major donors, particularly those with higher incomes, could entice them to give when they might not have or make a larger gift than they would have.

Old Law-Deduction Limitation

Before you can understand the changes you need to know what existed before they were enacted.

Before last Friday, your donors could deduct their charitable gifts of cash (not stock or other appreciated property) only up to 50% of their Adjusted Gross Income (AGI). AGI is roughly total income minus deductions for alimony, IRA contributions, self-employment expenses and a few other items.

This 50% limitation generally impacts only the very generous. For example, donors who have substantial assets from which to make gifts but moderate income in relation to the magnitude of their giving. But it can effect a high income donor who makes an extremely large gift in relation to income.

The point is, there was a cap on deductibility in a calendar year. If a donor’s total charitable giving in cash exceeded half their AGI, they could not take the full deduction in the year they made their gift. They could carry the excess deduction forward for up to 5 years, subject to the same cap, if needed.

If you’ve ever had a donor tell you they “can’t” make any more gifts in a certain year, they may have donated up to this cap and did not wish to defer any deductions into the following year.

New Law-Deduction Limitation

The 50% limitation is suspended on gifts of

• cash
• made directly to public non-profits (not to Charitable Remainder Trusts (with a very unlikely exception), donor advised funds, private foundations, supporting organizations or Donor Managed Investment (DMI) accounts; Charitable Gift Annuities are very likely included and qualify for the new law)
• beginning August 28, 2005 and ending December 31, 2005.

Gifts that meet these criteria can be deducted up to 100% of Adjusted Gross Income. If total qualifying gifts exceed your donor’s AGI (not likely, but possible) the excess can be carried forward up to 5 years under the 50% limitation after 2005.

Old Law-Overall Limitation

Before last Friday, your donors faced an overall charitable deduction limitation if their AGI exceeded $145,950 ($72,975 for a married taxpayer filing a separate return). Their total charitable deduction was reduced by 3% of the amount their AGI exceeded the $145,950 threshold. But the deduction could not be reduced by more than 80%.

For a simple example, if donor Dave had an AGI of $146,000 and made total charitable gifts of $500, Dave’s deduction would be reduced by $1.50 (= .03 x $50 (the amount his AGI exceeds $145,950) to $498.50.

New Law-Overall Limitation

The 3% overall limitation on charitable deductions is suspended on gifts of

• cash
• made directly to public non-profits (not to Charitable Remainder Trusts (with a very unlikely exception), donor advised funds, private foundations, supporting organizations or Donor Managed Investment (DMI) accounts; Charitable Gift Annuities are very likely included and qualify for the new law)
• beginning August 28, 2005 and ending December 31, 2005.

Your donors can fully deduct charitable gifts that meet these criteria.

Applying this to IRAs

The “New Laws” can also apply to charitable gifts made from Individual Retirement Accounts (IRAs) or qualified (tax deferred) retirement plans, such as 401(k)s and 403(b)s, but donors who have not reached age 59 1/2 should take caution.

A gift directly from the retirement plan is not permitted. Amounts withdrawn from IRAs or qualified plans and given to a non-profit must be reported as income for all donors, irrespective of age.

As described above, there is a charitable deduction which will offset income tax due on the increased income, but suspension of the 3% cap only applies to the charitable deduction, not other deductions such as medical expenses and mortgage interest.

Thus, if the increased income from the IRA withdrawal puts your donor over the $145,950 threshold ($72,975 for a married taxpayer filing a separate return), the 3% overall limitation will start reducing the other deductions, up to 80 percent of their value.

Clearly, your donor needs their own professional tax advisor to help them decide whether any of KETRA’s provisions can benefit them.

Conclusion

KETRA created valuable tax incentives for your higher income donors to consider as they make decisions about their year end giving. Your responsibility is to educate your constituents to make them aware that short-lived inducements may help them increase their giving to your organization before 2005 comes to a close.