Good News and Bad News

While its most commonly used name doesn’t hint at it, the Pension Protection Act of 2006 actually includes giving incentives and a number of reforms designed to increase regulation of exempt organizations.

Since your organizations are most certainly affected by this legislation, I will therefore explain in easy-to-understand terms the main points you must concern yourself with. I must provide the following warning: the Pension Protection Act of 2006 (PPA)¹ is such a massive piece of legislation that I can only skim its surface in this short article.

The Joint Committee on Taxation’s explanation of provisions that affect exempt organizations is more than 100 pages long.² A summary provided by the Committee on Ways and Means is a merciful four pages.³

I trust that you will seek more guidance on the new provisions as you need it. For many of you, questions will arise as you prepare your annual Information Returns on newly revised Forms 990 that reflect PPA mandates. The PPA’s two main sections include Charitable Giving Incentives and Reforming Exempt Organizations.

The Charitable Giving Incentives are relatively minor. They continue the tax-free treatment of certain distributions from IRAs (Individual Retirement Accounts) of up to $100,000.⁴ They provide higher deductions for contributions of food and book inventories, and certain conservation properties. There are new reporting requirements for transfers between controlled and controlling organizations.

The Charitable Reform provisions are sweeping. Some of them, such as donations of historic easements or taxidermy, probably aren’t of interest to you. These are the provisions nonprofit human service organizations need to be aware of:

• Excise taxes on prohibited excess benefit transactions are doubled. (See my article entitled “It’s Time to Get Serious About Intermediate Sanctions” in the fall 2002 issue.)
   
• A donor of tangible personal property must pay back any tax benefit if the donee organization does not use it for exempt purposes (see sidebar for details).
   
• Donors cannot take deductions of more than $500 for gifts of clothing or household items unless they are in good used condition or better, and deductions for de minimus gifts such as used socks and underwear are disallowed altogether.
   
• Donors who give cash in any amount must maintain either (1) a cancelled check, (2) a receipt from your organization, or (3) other reliable written records of the donation showing your name, the date of the gift, and the amount given. Prior substantiation requirements for contributions of $250 or more remain in effect.
   
• Fractional and future interests in tangible personal property are no longer recognized in most cases.
• Exempt organizations must report to the IRS the receipt of direct or indirect interests in life insurance contracts. Penalties are imposed for failing to report.
   
• Appraisers who aid and abet in overstating the value of donated property can be fined, and the IRS is authorized to regulate the practice of appraisers who practice in this area.
   
• The IRS may disclose certain information about regulatory matters to state officials. This includes denials of exemption, revocation actions, tax deficiencies, and information from filed Form 990 returns.
   
• Form 990-T returns (reporting taxable unrelated business income) must be disclosed in the same way that Forms 990 are now disclosed.
   
• The IRS is instructed to study Donor Advised Funds and Supporting Organizations, and transition rules for their operation in the meantime are provided.

Donor Advised Funds and Supporting Organizations

Because many child welfare organizations are the recipients of contributions through donor advised funds and other supporting organizations, it is worthwhile to look at initiatives that the IRS has in mind for these entities. Billions of dollars are held by these entities, and my guess is that most of you are the beneficiaries of one or more of them.

Donor Advised Funds (DAFs) have been around for many years, but they had mostly been modest operations within large community funds. In the past decade, there has been a huge growth in the use of donor advised funds by commercial banks and investment houses. DAFs allowed donors to retain a great deal of discretion over the funds while they benefit from charitable deductions allowed under the code. The IRS sees that many DAFs are identical in every way to private foundations, but because they are not recognized as such by the IRS, they escape private foundation limitations.⁵

Supporting Organizations (SOs) are entities that don’t themselves do any exempt work, but are given public charity status because they are attached in some way to an organization that is a 501(c)(3) public charity. The Pension Protection Act creates categories based upon the amount of control that the charity exercises over the SO, and gives the IRS regulatory tools that differ from one category to another.⁶

The PPA instructs the secretary of the treasury to engage in a study in order to recommend changes that will re-establish the integrity of donations that are funneled through DAFs and SOs. The IRS in the meantime is acting quickly to shore up the review process so that it can require greater control by the donee organization (that is, the charity that is to ultimately receive the gift) before a gift is considered complete.

If your agency is the recipient of funds from DAFs or SOs, you may be asked to submit information to the IRS explaining how the entity is related to yours. The IRS will want to know whether your organization has total control over the funds or whether the donor retains the ability to impose material restrictions on their use.

ENDNOTES

1. The Pension Protection Act of 2006 is also known as H.R. 4. It was signed into law by President Bush on Aug. 17, 2006.

2. "Technical Explanation of H.R. 4, the Pension Protection Act of 2006 As Passed by The House on July 28, 2006, and as Considered by the Senate on August 3, 2006.” The report, prepared by the staff of the Joint Committee on Taxation, is available online. 

3. "The Pension Protection Act of 2006: Detailed Summary of Charitable Provisions.” The summary, prepared by the Committee on Ways and Means, is available online.

4. The rules for qualified charitable distributions from IRAs are complex. Donors who might qualify should work with their tax advisors or IRA plan advisors to ensure compliance with PPA requirements.

5. Private foundations usually have a small base of donors, often a single family, and they are highly regulated so that they will not be used as an illegal tax shelter. For more information about private foundation limitations, see “Life Cycle of a Private Foundation” at the IRS website.

6. Supporting organizations are described in Section 509(a)(3) of the Internal Revenue Code, 26 U.S.C. 509(a)(3). An excellent description, including charts, is found in a July 2006 GAO report.

Kathryn Vanden Berk practiced law for nine years before serving as the president of two residential treatment centers for children. Now practicing in Chicago, she focuses on nonprofit start-ups, corporate and tax law, and employment issues. She serves as adjunct faculty at several Chicago universities, and is a member of the Advisory Board of the Axelson Center for Nonprofit Management at North Park University. She authored a handbook on starting nonprofits that is available from the Nonprofit Financial Center, Chicago, and a chapter in the Illinois attorney’s handbook Not-for-Profit Corporations, 2004 Ed., Illinois Institute of Continuing Legal Education. In 2004 she authored Retooling Employment Standards for the Future, a publication of the First Nonprofit Educational Foundation, Chicago. She can be reached by e-mail or at 312-558-1690.

View the archive of Nonprofit Law columns or the archive for all columnists.

Article PDF: 

Alliance_Magazine_Summer07_Nonprofit_Law.pdf