THE PENSION PROTECTION ACT
In addition to requiring corporations to more fully fund their pension plans, the Pension Protection Act (“PPA”), which was passed on August 17, 2006, provides or extends numerous tax benefits that could affect you or your employer. The PPA recognizes the reality that the government and many companies are pushing the responsibility of saving for retirement on to individuals. To help us take on that responsibility, the PPA provides greater tax deferred savings opportunities for all and offers favorable tax treatment for certain beneficiaries named under a Retirement Savings Account.
Estate Planning – Additional Opportunities for Your Loved Ones to Stretch Your Retirement Savings after your Death
From a planning perspective, perhaps the most important new provision of the PPA is to allow non-spousal beneficiaries to “roll over” assets inherited from a qualified retirement plan into an IRA. The beneficiary will avoid tax on the rollover, and will be taxed only when the assets are withdrawn. Previously, this tax treatment was available only for people who inherited retirement assets from a deceased spouse. The new law extends treatment that already exists for IRAs and will primarily benefit children, grandchildren domestic partners and non-traditional couples.
Specifically, the surviving beneficiary will now be able to “roll over” the decedent’s retirement funds into an Individual Retirement Account (IRA) and either draw down the benefits over a five-year period or over such beneficiary’s own life expectancy. Since the terminology in this particular field is imprecise and confusing, it must be clearly stated that the term “roll over” as used here does NOT allow a non-spousal beneficiary to merge the decedent’s qualified retirement plan with their own. It merely allows the beneficiary to take withdrawals over the beneficiary’s life expectancy rather than being forced to withdraw the entire amount as a lump sum and incur immediate tax charges. This particularly important because this forced withdrawal often bumped the survivor into a higher tax bracket as the withdrawal is counted as taxable income to the beneficiary.
In order for your loved ones to benefit from this new law, you MUST properly designate a beneficiary under your retirement account. If you have not done so, contact your employer’s benefits coordinator and fill out a beneficiary designation form, otherwise they will not receive the benefit of this new law. Unfortunately, the pension plan that your employer uses still determines who you can name as beneficiary. If the pension plan currently does not allow distributions to anyone other than to a spouse, this provision in the PPA will not help you.
The amendments made by this section of the PPA shall apply to distributions after December 31, 2006
Note: The transfer to the beneficiary must be done as a direct rollover, also known as a Trustee to Trustee transfer, otherwise the tax benefits of this rollover will be lost! The direct transfer must go to a properly titled inherited IRA, which means the inherited IRA must be maintained in the named of the deceased plan participant. For example, “Grandpa’s IRA (Deceased March 1, 2007) FBO grandson”.
Retirement Planning Opportunities
The new law extends a number of retirement benefits. The contribution limit for IRAs will be $4,000 in 2006 and 2007, $5,000 in 2008, and adjusted for inflation after 2008. Catch-up contributions for individuals age 50 or older will be $1,000 for IRAs, $2,500 for SIMPLE-IRAs, and $5,000 for 401k plans. IRA catch-up contribution limits, however, will not be adjusted for inflation. SIMPLE and 401k catch-up contributions will be adjusted in $500 increments based on inflation.
The new law permanently allows for Roth 401k and Roth 403b plans. Under the sunset provisions of the previous tax law, Roth-type 401k and 403b plans were not allowed after 2010. The new law removes this sunset provision. Like a Roth IRA, an individual makes post-tax contributions to a Roth 401k or Roth 403b plan, up to the plan limits. The assets grow tax-deferred and may be withdrawn tax-free in retirement.
If you are in a low income tax bracket, you may wish to take advantage of a provision in the PPA that allows a direct rollover from a 401k to a Roth IRA, with the rollover treated as a Roth conversion.
The new law also permanently allows the Retirement Savings Tax Credit, which would have expired at the end of 2006.
How the PPA may affect an Employer
Employers may now automatically enroll their employees into a 401(k) retirement plan using default contribution levels. Employees will need to opt-out of the 401(k) if they don't want to utilize the 401k plan.
Military personnel who are called to active duty between September 11, 2001 and December 31, 2007, may now take a penalty-free withdrawal from their 401(k) or IRA. However, these individuals must re-deposit the withdrawal within two years from time their active duty ends in order to avoid paying income tax on the withdrawal.
The PPA makes it much easier to make hardship withdrawals from 401k plans including allowing hardship withdrawals "with respect to any person listed as a beneficiary under the 401(k) plan." Beneficiaries such as siblings, parents, same sex couples, and children may now draw on a retirement fund in the case of a qualifying medical or financial emergency. In the past, the federal law covered only the spouses or dependents of employees when it came to accessing retirement funds during an emergency.
Stricter Rules for Charitable Donations
Under the new law, taxpayers must keep records of all cash donations to charity. Individuals must show a receipt from the charity, a canceled check, or credit card statement to prove their donation. No charitable tax deduction will be allowed if the taxpayer cannot provide any supporting documentation. Taxpayers will not need to mail in the receipts with their tax return. Instead, taxpayers will need to keep receipts and other documentation with their copy of the return in the event of an IRS audit. The Law Office of Kevin A. Pollock LLC strongly recommends that you maintain all such records for a minimum of seven years.
The new law also toughens the rules for non-cash donations. Donated items, such as clothing, cars, and household goods, must be in good condition. Unfortunately, the new law does not offer any guidance as to what “good condition” means.
Charitable IRA Donations
The Pension Protection Act allows taxpayers to donate up to $100,000 to charity directly from their IRA account in 2006 and 2007. The distributions will be tax-free and avoid the penalty on early withdrawals. Taxpayers are allowed to donate up to $100,000 per year from their IRA. Since the distribution will not be included in taxable income, individuals will not be able to claim a tax deduction for the charitable contribution.
Qualified Charitable Distributions from IRAs Allowed
· Under pre-Act law, there was no provision permitting the tax-free distribution from an IRA where the distribution was to be donated to a charity. The Act provides a favorable new rule that permits an exclusion from gross income, not to exceed $100,000 per year for otherwise taxable distributions from a traditional IRA or a Roth IRA that are made:
o directly by the IRA trustee to qualified public charities and certain private foundations (but not to most private foundations, supporting organizations and donor advised funds);
o on or after the date the IRA owner attains age 70½; and
o only for distributions made in 2006 and 2007, without carryover to any subsequent year.
· Distributions that are excluded from gross income are not taken into account in determining the IRA owner’s deduction for contributions to charity, but are counted as part of the IRA owner’s required minimum distribution for that year.
· The benefit arises from not including the IRA distribution in adjusted gross income, those affected by limitations on itemized charitable donation deductions, and for taxpayers who do not itemize their deductions.
Section 529 College Education Plans Made Permanent
· Withdrawals from Section 529 Plans for qualified college expenses have been completely exempt from Federal income taxes since 2002. However, this valuable tax benefit was set to expire in 2011. The new Act makes permanent the tax benefits of Section 529. Distributions for qualified educational expenses (including special needs
Gifts of Fractional Interests in Tangible Personal Property
· The Pre-Act law allows a charitable deduction for a contribution to charity of a fractional interest in tangible personal property if the contribution satisfies requirements for partial and future interests, and in later years the donor makes additional charitable contribution of interests in the same property. A common use of this provision was to make a gift of a percentage interest in a painting or other artwork to an art museum; in theory, the museum must have use and possession of the art for part of each year commensurate with its percentage interest.
· For contributions, bequests and gifts made after August 17, 2006, the Act limits the charitable deduction for such fractional interest contributions, provides rules for valuing the donor’s additional fractional interest contributions and provides for recapture of the tax benefits under certain circumstances.
· The Act requires that the charitable entity receiving a fractional interest must take complete ownership of the item within 10 years of the gift, or the death of the donor, whichever first occurs. Further, the entity must take possession of the item at least once during the 10-year period as long as the donor is living, and use the item for the entity’s exempt purpose. Failure to comply results in the recapture of all tax benefits plus interest and imposition of a 10% penalty. The more restrictive 10-year rule is likely to deter many younger donors from making fractional interests gifts, since enjoyment during the balance of the donor’s lifetime is no longer possible.
· There are also special rules for deductions of future gifts of partial interests in the same property. In general, for items that are contributed to further a donee’s exempt purposes, the deduction will be equal to the fair market value of the interest. The fair market value of an additional contribution of a partial interest in this case is the lesser of the item’s fair market value at the time of the initial contribution or the fair market value at the time of the current contribution. The additional rules that limit the charitable deduction which apply for income tax purposes, also apply for gift and estate tax purposes. There is a potential gift and estate tax trap when the donor makes a transfer of his remaining interest in the property if the property has appreciated in value from the time of the initial contribution, since the interest that remains in the donor’s estate at the time of his death is valued at its full value, while the estate tax deduction is limited to the value of the property at the time of its contribution.
Tougher Record Keeping Required for Charitable Gifts of Money
· The Act disallows any charitable deduction for contributions of cash, check or other monetary gift made after December 31, 2006, unless the donor maintains a written record of the contribution, regardless of the amount. For a contribution of cash, the donor must maintain one of the following (i) cancelled check, (ii) receipt (or letter or other written documentation) from the entity showing the name of the entity, the date and amount of the contribution or (iii) other reliable written records showing the name of the entity, the date and amount of the contribution. The existing rule for requiring a written receipt from the charity for cash contributions of $250 or more remains in effect.
Limitations for Charitable Gifts of Clothing and Household Items
· The Act restricts the charitable deduction for donations of clothing or household items unless they are in good used or better condition. Thus, effective after August 17, 2006, items donated in poor condition will not result in a charitable deduction.
Tougher Rules for Donated Tangible Personal Property
· For contributions made after September 1, 2006, there is a recapture of the tax benefit for charitable contributions of tangible personal property exceeding $5,000 for which a fair market value deduction is claimed unless the charity uses the property for its exempt charitable purposes. If the charity disposes of the donated property within 3 years from contribution, the donor is subject to an adjustment of the tax benefit arising from the contribution. However, there is no adjustment if the donee entity makes a proper certification to the IRS, a copy of which must be given to the donor.
· To encourage charitable contributions of real property for qualified conservation, the Act increases the percentage limitation applicable to qualified contributions of real property from 30% to 50% (100% for qualified ranchers and farmers) and increases the carryover period for qualified conservation contributions that exceeded percentage limitation from 5 to 15 years. This provision is effective for contributions in 2006 and 2007.
New Taxes on Prohibited Benefits Received from Donor Advised Funds
· In order to close a perceived loophole under current law, the Act provides that if a distribution from a donor advised fund results in a donor, donor advisor, or a related person receiving, directly or indirectly, more than an incidental benefit as a result of the distribution, then: (i) a tax is imposed on the fund manager equal to 125% of the amount of the benefit is imposed on the advice of any related person to have a sponsoring organization make the distribution and such person who advises that the distribution be made or who receives the benefit pays the tax; (ii) a tax equal to 10% of the amount of the benefit is imposed on the agreement of any fund manager who makes the distribution that confers a benefit up to a maximum of $10,000. This provision is effective for tax years after August 17, 2006.
Benefit to S Corporation Shareholders for Charitable Contributions
· Under the Act for tax years beginning in 2006 and 2007, if an S corporation makes a charitable contribution, its shareholders will now reduce their basis in the stock of the S corporation only by their pro rata share of the adjusted basis of the contributed property. Under the prior law, their stock basis had to be reduced by their pro-rata share of the entire charitable contribution. This provision now treats S corporation shareholders the same as partners in a partnership. For example, if an S corporation having a sole shareholder makes a charitable contribution of stock with a basis of $200 and a fair market value of $500, the shareholder will be treated as having made a $500 charitable contribution and will reduce the basis of his or her stock by $200. This is only a temporary tax incentive to encourage S corporations to make charitable donations of appreciated assets in 2006 and 2007.
Enhanced Taxpayer Penalties for Valuation Misstatements
· For returns filed after August 17, 2006, the Act increases the accuracy-related penalties imposed on taxpayers for income, estate or gift tax understatements of value. Under the Act, a “substantial” estate or gift tax valuation misstatement occurs when the claimed value of the property is 65% (previously 50%) or less of the correct value. A “gross” estate or gift tax valuation misstatement exists when the claimed value is 40% (previously 25%) or less of the correct value.
Filing Requirements for Split-Interest Trusts
· The Act increases the penalty on split-interest-trusts (e.g. charitable remainder annuity and unitrusts and pooled income funds) for failure to file a return and failure to properly report required information. The penalty is $20 for each day the failure continues up to $10,000. For trusts with gross income in excess of $250,000, the penalty is $100 per day up to $50,000. If any officer, director, trustee or other individual under a duty to file or include required information, knowingly fails to file the return or include required information, such person is personally liable for such penalty, in addition to the penalty imposed upon the entity. This provision is effective for taxable years after December 31, 2006.