The Pension Act Isn’t Just About Pensions!

By R. Michael Sorrells, CPA
National Director Nonprofit Tax Services

In addition to containing a massive overhaul to many of the retirement plan rules, the Pension Protection Act of 2006 contains many additional "add-on" provisions affecting tax exempt organizations. Some of these provisions represent significant changes for a lot of organizations. This article will briefly summarize the major nonprofit provisions and their effect on various types of nonprofits. We will leave analysis of the Act's retirement plan law changes (which can affect both for-profit and nonprofit entities) to the benefits experts. Most of the provisions are effective as of the date the President signed the Act, August 17, 2006. We will note any effective dates that differ.

Notification by Organizations Not Required to File Form 990: For tax years beginning after 2006, organizations that do not have to file Form 990, now have an annual electronic filing requirement with the IRS that contains some very basic contact and other information. Failure to make this notification can result in an organization losing its exemption. This applies to small organizations (less than $25,000 in gross revenue) and to churches which under previous law had no filing requirements with the IRS. The IRS will provide instructions for this electronic filing on their web site soon.

Public Disclosure of Form 990-T: Under prior law, the only annual forms subject to public inspection were information returns, Forms 990 and 990-PF. Now, for 501(c)(3) organizations, the Form 990-T tax return for unrelated business income is subject to public inspection. Since public inspection also entails posting on the Internet by Guidestar, charities may have a new incentive to assure themselves that tax positions, allocations and calculations on the 990-T are presented completely and accurately.

Unrelated Business Income (UBI) from Controlled Entities: In general, passive income such as interest, rent and royalties are excluded by statute from UBI. However, in the case of a taxable subsidiary with greater than 50% ownership by a nonprofit, such income is considered as gross UBI (although there may be offsetting expenses on the nonprofit's books). This treatment, under Sec. 512(b)(13) was added several years ago to stem abuses where a subsidiary was able to avoid tax by taking a large deduction for a payment to a nonprofit that did not have to pay tax on the receipt. This is now modified by making taxable only the portion of such payments that is greater than fair market value. Thus, organizations with such payments from controlled subsidiaries will have to document exactly what the payment should be in an arms-length transaction between unrelated parties. It clearly will benefit for the payment to be set at a level that is no higher than FMV since the new provision not only makes the excess taxable, but puts a 20% excise tax on such excess. Additionally, nonprofits that receive rent, interest, royalty or annuity payments from controlled entities must report this on form 990 along with amounts of loans and transfers to the controlled entity in a separate statement. This is a requirement for any 990s filed after August 17th, even though the instructions for form 990 will not include this information until 2006 instructions are released in 2007. A structured attachment to report this information will be available from the IRS later this year.

Donor Advised Funds (DAFs): While the IRS has allowed DAFs to obtain 501(c)(3) exempt status, there has been an increasing suspicion by Congress and the IRS that such funds are often abusing their exempt status. The Pension Protection Act contains the following provisions directed at DAFs:

• Requires that the Treasury Secretary conduct a study to determine that charitable donations to a fund's sponsoring organization are appropriate
• Levies penalty tax on certain DAF distributions for non-charitable purposes, distributions without expenditure responsibility or distributions to a natural person. Tax is 20% of the distribution and fund manager can be subject to 5% penalty limited to $10,000.
• Imposes a 125% tax on person advising the DAF on a distribution which results in a more than incidental benefit to that person. Fund managers are subject to a 10% tax on this kind of distribution, limited to $10,000.
• Imposes the private foundation tax on excess business holdings
• Subjects any grants, loans and compensation to a person who is a donor, donor advisor or related person to the intermediate sanctions rules.
• Requires certification from DAFs in acknowledgement notices to donors that it has control over the contribution

Type III Supporting Organizations: "Type III" supporting organizations have always been problematic to the IRS since they only have to be operated in connection with another organization and not controlled by that organization. Major provisions enacted for Type III organizations:

• Requires that the Treasury Secretary conduct a study to determine that charitable donations to this kind of supporting organization are appropriate
• Requires that Type III's only support U.S. organizations, and must supply information to the organization that it is responsive to its needs.
• Prohibits these entities from receiving donations from a person who controls the supported organization
• Requires minimum distributions to the supported organization

Provisions for all Supporting Organizations:

• Imposes the private foundation tax on excess business holdings
• Imposes excess benefit tax on payments to a substantial contributor
• Requires all supporting organizations to report on Form 990 the type of supporting organization, a list of supported organizations, and certification that it is not controlled by a disqualified person.

Expanded Reporting for Split-Interest Trusts: Under prior law, split-interest trusts (charitable remainder unitrusts, charitable remainder annuity trusts, pooled income funds) did not have to file an information return, Form 1041-A, if they are required to distribute all of their net income currently. This exception is now gone-these trusts have to file Form 1041-A for years beginning after 2006. This is an important change to note as penalties have been greatly increased and are applicable personally to directors/trustees who knowingly fail to file a return.

Charitable Giving Provisions:

• Tax-Free Distributions from IRAs: Under existing rules, a distribution from an IRA contributed to a charity was a taxable event-the donor took it into taxable income and then took a charitable deduction (subject to various limitations). Under the new rules, effective for 2006 and 2007, an IRA distribution made directly to a 501(c)(3) organization after the IRA owner attains age 70 & 1/2, is a tax free distribution. This should have be an incentive for charitable contributions as it provides tax savings for donors in a variety of tax situations. Donations to support organizations or donor advised funds are not eligible for this treatment.
• Donations Not Used For Exempt Purpose: Generally, donations of property are allowed a charitable deduction of fair market value unless the property is not used for the organization's exempt purpose (then limited to donor's basis). For returns filed after September 1, 2006, if the donee organization sells or disposes of tangible personal property with a claimed value of $5,000 or more within the year of the donation, the contribution is limited to basis. If disposed within the next two years, the taxpayer has to include in income the difference between the claimed deduction and basis. If the organization informs that IRS that donation was originally exempt use property but it later became impossible to use the property, then these rules do not apply and donor can take the entire donation at fair market value. There is a $10,000 penalty for falsely stating that property is exempt use when it is not.
• Extension of Katrina Food Inventory Deduction: Generally a taxpayer's deduction for inventory contributions is limited to cost or, if less, the fair market value of the inventory. C Corporations are allowed an enhanced deduction for certain inventory donations: the lesser of the basis of the inventory plus one-half the profit if sold at FMV; or twice the basis of the inventory. Emergency Katrina legislation extended this deduction through December 31, 2005 for food inventory donations by non-C Corp taxpayers engaged in a trade or business. This enhanced deduction has been extended through 2007.
• Book Donations to Schools: Under Katrina legislation, C Corporations were allowed the enhanced deduction (see above) for donations of books to public schools (which are not under 501(c)(3)) through December 2005. This has been extended through 2007.
• Donations by S Corporations: Under existing rules, when property donations made by S Corps pass through to the shareholders, they had to reduce their basis in S Corp stock by the fair market value of the property. Under new provision, basis is only reduced by adjusted basis in the donated property. This should be an incentive for contributions through S-Corporations-it applies to contributions made in 2006 and 2007.
• Clothing and Household Item Donations: No deduction to be allowed for items not in good used condition or better (unless, for items valued at $500 or more, an appraisal is filed with the tax return). Deductions may be denied for items with minimal value such as underwear or socks.
• Conservation Contributions: Several provisions were added for 2006 and 2007 that encourage real property conservation contributions.
• Taxidermy Contributions: Evidently, there have been some abuses in what would seem an esoteric donation area. Deduction after July 25, 2006 is limited to lesser of basis or fair market value. Basis is limited to cost of preparing, stuffing or mounting the animal.

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