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Hurricane Katrina Relief Bill
The Hurricane Katrina relief bill, unanimously passed by the House and Senate on September 21, and signed into law by the president on September 23, has made changes to tax law designed to encourage certain outright gifts of cash made during the period August 28, 2005 thru December 31, 2005.
- The contribution limit for certain outright gifts of cash has increased from 50 percent of adjusted gross income to 100 percent of adjusted gross income.
- These same outright gifts of cash also are exempt from the three-percent reduction in itemized deductions for individuals with an adjusted gross income over $145,950.
- Cash gifts to a private foundation, supporting organization, or donor advised fund do not qualify for the higher limit or the three-percent rule exemption.
- These changes may present some donors with an attractive opportunity to fund outright gifts with assets withdrawn from an IRA or other qualified retirement plan.
Under existing law, the maximum amount of cash contributions that is deductible in any one year is 50 percent of adjusted gross income. That limit is being increased to 100 percent of adjusted gross income in the case of certain cash gifts made during the stipulated period.
Consider this example: An individual with adjusted gross income of $200,000 made contributions to various charities amounting to $50,000 prior to August 28. Wanting to help charities involved in Katrina relief, as well as other charities whose donations are down because dollars that normally would have flowed to them have been diverted for Katrina relief, this individual contributes $150,000 cash to certain public charities between August 28 and the end of the year. This donor will be able to deduct $200,000 for 2005, resulting in zero income tax. Prior to the increase in the deduction limit, this donor would have been able to deduct only $100,000 in 2005, though the excess could have been carried forward for up to five additional years.
A contribution to a private foundation, a supporting organization, or a donor advised fund would not qualify for the higher limit. A contribution to a public charity, whether or not that charity is engaged in Katrina relief, and whether or not the contribution is unrestricted or for a designated purpose, would qualify.
Still another benefit of making qualified cash gifts before the end of the year is that they will not be subject to the reduction rule applicable to itemized deductions. In general, a taxpayer's itemized deductions must be reduced by three percent of the amount by which adjusted gross income exceeds $145,950. However, there is no such adjustment for qualifying cash contributions made from August 28 through December 31. As with the 100 percent contribution limit, all donations made prior to August 28 and non-cash donations made at any time in 2005 will continue to be subject to this three-percent reduction rule.
An Opportunity for People with IRAs and Qualified Retirement Plans
Because of the increase in the deduction limit, people who have more money in their IRAs or other qualified plans than they will likely need for retirement security, and who are at least 59 and 1/2 years of age, may want to consider withdrawing assets and contributing them to a charity. Upon withdrawal, the assets, as before, will be added to adjusted gross income, but the full amount added to income will then be deductible from income, resulting in a "wash."
Before taking such action, donors should consider how increasing their adjusted gross income may reduce the amount they can deduct for medical expenses and casualty losses, accelerate the phase-out of personal exemptions, and cause some loss of other itemized deductions. Although the amount withdrawn from an IRA or other qualified plan and then contributed will not be affected by the three-percent reduction in itemized deductions, other itemized deductions, as well as the personal exemption, may be diminished with a rise in adjusted gross income.
Notwithstanding these possible consequences, withdrawing and contributing assets from an IRA or other qualified plan during this window of opportunity may make sense.
Consider this example: An individual has adjusted gross income of $200,000 and wants to give $500,000 to various charities in 2005. The donor, age 65, has well over $1 million in a qualified retirement plan. If the donor makes these contributions by withdrawing $500,000 from the retirement plan during the stipulated period, the donor's adjusted gross income will increase to $700,000 and the entire $500,000 in contributions will be deductible. Increasing the donor's adjusted gross income from $200,000 to $700,000, however, may increase the donor's income tax in other ways by diminishing the availability of the donor's other itemized deductions and personal exemptions.
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