2006
RETIREMENT LAW CHANGES AFFECT INDIVIDUAL TAXPAYERS
by
Michael
Kaufman
The Pension Protection Act of 2006, enacted August 17, made a number of changes that apply to individual taxpayers’ ability to make or claim a deduction for charitable contributions and changed some tax consequences for beneficiaries of retirement plans. Below are some highlights of the changes in the tax law that have particular application to individuals and families.
Direct, Tax-Free Contributions From IRA Accounts May be Made to Charities Through December 31, 2007
Under the new law, taxpayers ages 70½ or older may direct tax-free distributions to be made directly from their IRA, generally only to qualified public charities, and only through December 31, 2007. The maximum annual amount any taxpayer may contribute in this way is $100,000.
Previously, if you wanted to use proceeds from your IRA to benefit a charity, you would have to take a distribution from the IRA and then make a gift to the charity. The IRA distribution would have raised your taxable income, possibly causing you to shift into a higher marginal tax bracket or making otherwise untaxed Social Security benefits subject to tax. You also then may or may not have been able to use an offsetting charitable income tax deduction for your contribution, depending on your personal tax situation.
Under the new law, you may direct your IRA trustee to distribute funds directly from the account to a qualified charity and pay no income tax on that distribution. However, since you will not owe any income tax on this charitable gift, you will not be able to claim the distribution as a charitable contribution on your tax return. These distributions to charity do satisfy your minimum distribution requirements from the IRA, however, potentially saving the income taxes otherwise due on that amount.
Over the next few weeks, administrators of IRAs will be implementing their own rules for handling these kinds of distributions. You will need to check with your specific account trustee to see if there are any limits they impose.
Non-Spouse Beneficiaries May Rollover
Retirement Funds
This new law allows any beneficiary (sibling, parent, child, partner, etc.) of your corporate sponsored retirement plan (401(k), 403(b), or similar plans) to rollover account proceeds payable to the beneficiary after December 31, 2006, into an “inherited IRA.” (IRA beneficiaries could already do this.) This allows any surviving beneficiary to be able to elect to receive distributions throughout the length of his or her life expectancy, and thereby spread the impact of the income taxes payable on those distributions over that period. Previously, only legal spouse beneficiaries had a rollover opportunity - other beneficiaries could have been forced to withdraw the entire amount as a lump sum or over no more than five years, incurring an immediate income tax liability on the proceeds received and potentially being pushed into a higher tax bracket. The new law avoids this immediate income tax and also allows the assets that remain in the IRA account to continue to accumulate income tax free.
Non-Spouse Beneficiaries of Retirement Plans Eligible for Hardship Distribution Rules
Under the new law, everyone may now have access to laws that permit people to draw on their qualified retirement funds in the case of a qualifying medical or financial emergency. In the past, federal law covered only the participant, a legally recognized spouse or a dependent, when it came to accessing retirement funds during an emergency.
If any person named as a beneficiary of your qualified retirement account has financial hardship with which you want to help, you may be able to request a hardship withdrawal from your 401(k) or similar plan to help cover the expenses. Note that hardship withdrawals are subject to income tax. The types of hardships described in the law that can give rise to an allowable distribution include medical bills, tuition/education costs, payments to prevent eviction from home, and funeral expenses.
Whether or not you will actually be able to take advantage of this opportunity will depend on two things. First, the IRS has until February 13, 2007, to issue regulations on how this will work. Second, once that happens, your retirement plan will need to adopt an amendment to include these new provisions. You may want to check with your employer about when and whether they plan to include these provisions.
Changes in Rules for Donations of Cash, Clothing, Household Items, and Other Items
In a major change that will affect many taxpayers, in order to deduct a charitable contribution from your taxes, the IRS will now require a written record for each gift. Under current law, documentation has only been required for contributions of $250 or more. Receipts or canceled checks do not have to be submitted with your tax return, but can be demanded if the taxpayer is audited. If the proper proof is not provided, the deductions can be disallowed.
Rules on donations of old clothing and household items have also been changed. Deductions can now only be taken if the donated items are in “good” condition or better – exactly what this means is not clear since the new law does not define “good” condition. Donated items in “fair” condition valued at $500 or more can be deducted but only if the taxpayer gets an appraisal to prove the value.
This change in rules increases the burden on the taxpayer to maintain written records of all contributions made during the year.
No Sunset of Certain Retirement
and Education Incentives
Under current law, many retirement savings incentives enacted in the 2001 income tax law would have ended after December 31, 2010. For example, without the Pension Protection Act, IRA contribution limits would have reverted to the 2001 level of $2,000 per year and the ability to make catch-up contributions would have ended. The new law repeals "sunset" provisions on many such incentives; as such, these incentives will remain in place. This should make long-range retirement planning easier. The current beneficial treatment of section 529 Qualified Tuition Plans, which had been set to expire in 2010, has also now been made permanent.
If you have any questions about any of these
documents, or if we may be of any other
help, please contact your Jackson Walker
estate planner or Michael Kaufman at mkaufman@jw.com/214.953.5734.
