Tax-Free IRA-to-Charity Transfers

In general, distributions from IRAs are taxable and deductions for charitable contributions are limited. Effective for distributions made in taxable years beginning after December 31, 2005, and taxable years beginning before January 1, 2008, these limitations are suspended. Specifically, the Act provides an exclusion from gross income for otherwise taxable IRA distributions. The exclusion applies to qualified charitable distributions from a traditional or a Roth IRA (not SEPs or SIMPLE IRAs), and may not exceed $100,000 per taxpayer per taxable year. A qualified charitable distribution is generally any distribution from an IRA directly by the IRA trustee to a charitable organization, but only if made on or after the date the IRA owner attains age 70-1/2.

Reduction of Certain Charitable Contributions

As a general rule, a donation of tangible personal property may entitle a taxpayer to an enhanced tax deduction equal to the property’s fair market value. Under the Act, care must now be exercised with respect to such contributions. The deduction is now reduced for charitable contributions of tangible personal property with respect to which a fair market value deduction is claimed in an amount in excess of $5,000 and which is not used by the donee organization for exempt purposes.

Specifically, if a donee organization disposes of applicable property within three years of the contribution of the property, the donor is subject to an adjustment of the tax benefit. If the disposition occurs in the tax year of the donor in which the contribution is made, the donor’s deduction generally is limited to the property’s basis and not its fair market value. If the disposition occurs in a subsequent year, the donor must include as ordinary income for its taxable year in which the disposition occurs an amount equal to the excess (if any) of the amount of the deduction previously claimed by the donor over the donor’s basis in the property at the time of the contribution. An exception to these new rules exists if the donee organization makes certain certified representations regarding the property to the IRS. This provision is effective for contributions made and returns filed after September 1, 2006.

Charitable Contributions of Clothing and Household Items

In computing taxable income, a taxpayer who itemizes deductions generally is allowed to deduct the amount of cash and the fair market value of property contributed to certain charitable organizations. The Act adds a new provision that restricts deductions of the contribution of clothing and household items. The deduction will now be permitted only if the clothing or household item is in good used condition or better. In particular, the IRS is authorized to deny a deduction for any contribution of clothing or a household item that has minimal monetary value. A deduction may be allowed, however, for a charitable contribution of an item of clothing or a household item not in good used condition or better, if the amount claimed for the item is more than $500 and the taxpayer includes with the taxpayer’s return a qualified appraisal with respect to the property.

Household items include furniture, furnishings, electronics, appliances, linens, and other similar items. Food, paintings, antiques, and other objects of art, jewelry and gems, and collections are excluded from the provision.

The new rule is effective for contributions made after August 17, 2006.

New Substantiation Rules for Cash Charitable Contributions

In a corollary provision, the Act changes the substantiation rules for charitable contributions of money, so that they now resemble the rules related to the substantiation for property contributions. The new rules now provide that, in the case of a charitable contribution of money, regardless of the amount, applicable recordkeeping requirements are satisfied only if the donor maintains a bank record or a written communication from the donee showing the name of the donee organization, the date of the contribution, and the amount of the contribution. Merely maintaining other written records will no longer satisfy the recordkeeping requirements. Note that, in lieu of cash, taxpayers may now wish to consider checks, since a cancelled check will qualify as substantiation. The new rules apply to tax years beginning after August 17, 2006.

Post-Death IRA Transfers

In the case of the death of a participant in a qualified retirement plan, the surviving spouse is placed in a somewhat favorable position with respect to alternatives available for benefits distributed by the plan. The law permits surviving spouses to defer taxation by rolling over benefits to an IRA. Historically, however, these advantages have not been available to nonspousal beneficiaries. Thus, if the plan required a distribution in cash, the nonspousal beneficiary had to pay an immediate income tax. Subject to certain limitations, the Act softens the adverse effect of this rule by providing that benefits distributed by a plan after 2006 to a nonspousal beneficiary may now be transferred directly to an IRA, thus permitting tax deferral.

Annual Retirement Plan Limitations

Many physician practices sponsor retirement plans. In addition to the Act, the Internal Revenue Service announced the impact of several cost-of-living adjustments and other provisions for 2007 that are relevant to taxpayers with retirement plans. Of particular importance, the limitation for defined contribution plans is increased from $44,000 to $45,000. The limitation on the exclusion for elective deferrals (for example, 401(k) plan deferrals) is increased from $15,000 to $15,500. The annual compensation limit is increased from $220,000 to $225,000. The dollar limitation concerning the definition of key employee in a top-heavy plan is increased from $140,000 to $145,000. The limitation used in the definition of highly-compensated employee remains unchanged at $100,000. The dollar limitation for 401(k) plan catch-up contributions for individuals aged 50 or over remains unchanged at $5,000. Finally, the Social Security wage base is increased from $94,200 to $97,500.

Health Savings Accounts

For practices with health savings accounts, the annual limits have also changed. For calendar year 2007, the monthly limitation for any month on deductions for an individual with self-only coverage as of the first day of the month is 1/12 of the lesser of (1) the annual deductible, or (2) $2,850. For calendar year 2007, the monthly limitation for any month on deductions for an individual with family coverage under a high deductible plan as of the first day of the month is 1/12 of the lesser of (1) the annual deductible, or (2) $5,650.

Further, for calendar year 2007, a "high deductible health plan" is defined as a health plan with an annual deductible that is not less than $1,100 for self-only coverage or $2,200 for family coverage, and the annual out-of pocket expenses (deductibles, co-payments, and other amounts, but not premiums) do not exceed $5,500 for self-only coverage or $11,000 for family coverage.

Other Tax Changes

For practices that are able to immediately expense certain purchases of fixed assets, the IRS announced an increase in the Section 179 expense limitation. For 2007, the annual expense limitation is increased to $112,000, and the annual property limitation is increased to $450,000. For physicians engaged in estate and gift tax planning, the annual gift tax exclusion remains at $12,000 for 2007. For practices with qualified transportation fringe benefits, the qualified parking fringe benefit is increased to $215 ($110 for transit passes) for 2007.

Finally, as a reminder, the Tax Increase Prevention and Reconciliation Act of 2005 curtailed benefits available for child tax planning by increasing the age to which the so-called Kiddie Tax applies. The Kiddie Tax increases the tax on certain unearned income of children so that the income is taxed at the top marginal rate of the parents. Specifically, for years after 2005, this rule applies to children under the age of 18. Prior to the new rule, the age limit was 14. Therefore, planning will be required to 2006 and later years.

The foregoing discussion is designed to summarize selected aspects of the tax law that may affect taxpayers in the completion of their returns for 2006 and in planning for the future. The reader is directed to address specific questions with his or her tax advisor.

Disclaimer

As provided in Treasury regulations, advice (if any) relating to federal taxes that is contained in this communication (including attachments) is not intended or written to be used, and cannot be used, for the purpose of (1) avoiding penalties under the Internal Revenue Code or (2) promoting, marketing or recommending to another party any plan or arrangement addressed herein.