Recent Tax Law Changes To Charitable Contributions

Individuals and businesses making contributions to charity should keep in mind several important tax law changes made last summer by the Pension Protection Act.

The new law offers older owners of individual retirement accounts a new way to give to charity. It also includes rules designed to provide both taxpayers and the government greater certainty in determining what may be deducted as a charitable contribution. Some of these changes include the following.

New Tax Break for IRA Owners

An IRA owner, age 70 ½ or over, can directly transfer tax-free, up to $100,000 per year to an eligible charitable organization. This option is available in tax years 2006 and 2007. Eligible IRA owners can take advantage of this provision, regardless of whether they itemize their deductions. Distributions from employer-sponsored retirement plans, including SIMPLE IRAs and simplified employee pension (SEP) plans are not eligible.

To qualify, the funds must be contributed directly by the IRA trustee to the eligible charity. Amounts so transferred are not taxable and no deduction is available for the amount given to the charity.

Not all charities are eligible under this provision. For example, donor-advised funds and supporting organizations are not eligible recipients.

Transferred amounts are counted in determining whether the owner has met the IRA’s required minimum distribution rules. Where individuals have made nondeductible contributions to their traditional IRAs, a special rule treats transferred amounts as coming first from taxable funds, instead of proportionately from taxable and nontaxable funds, as would be the case with regular distributions.

Rules for Clothing and Household Items

To be deductible, clothing and household items donated to charity after Aug. 17, 2006, must be in good used condition or better. However, a taxpayer may claim a deduction of more than $500 for any single item, regardless of its condition, if the taxpayer includes a qualified appraisal of the item with the return. Household items include furniture, furnishings, electronics, appliances, and linens.

Guidelines for Monetary Donations

To deduct any charitable donation of money, a taxpayer must have a bank record or a written communication from the charity showing the name of the charity and the date and amount of the contribution. A bank record includes canceled checks, bank or credit union statements and credit card statements. Bank or credit union statements should show the name of the charity and the date and amount paid. Credit card statements should show the name of the charity and the transaction posting date.

Prior law allowed taxpayers to back up their donations of money with personal bank registers, diaries or notes made around the time of the donation. Those types of records are no longer sufficient.

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Using IRA Funds For Your Children’s College Education

You can use IRA funds to pay for your kids' college. The 10% premature distribution penalty (which usually applies if you take money out before age 59-1/2) won’t apply to those taking money out to pay college expenses. But you will still owe income tax on the withdrawal—on all of it if all IRA contributions were deducted; on part of it, if some were nondeductible (see below for Roth IRAs).

We aren’t talking about what used to be called "education IRAs,” (now known as Coverdell Education Savings Accounts, or Coverdell ESAs) which are specifically designed to pay college expenses. We’re talking about pulling money out of retirement-oriented IRAs to pay tuition.

Tip: Money that’s in an IRA grows at a higher rate because there is no current tax on the growth. It’s important to leave the money in the IRA for as long as possible in order to get the most from that tax-privileged status.

By the way, with Coverdale "Education IRAs", contributions are limited to $2,000 per child per year. The contributions aren't tax-deductible, but money withdrawn from those accounts to pay for qualifying higher-education expenses will completely escape federal tax. So the education IRA is a good college-savings vehicle, though maybe not the only vehicle for your case.

What about money taken out of a Roth IRA (the non-deductible type of IRA) and used to pay for education? Roth IRA withdrawals are tax-free to the extent of prior nondeductible contributions, and you will escape the 10% penalty. Earnings withdrawn in excess of that can be taxable (and subject to the 10% penalty). But even earnings can come out of a Roth IRA tax-free if the account has been open for at least five years and you are at least 59-1/2 (or disabled).

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Missing Your Form W-2?

You should receive a Form W-2, Wage and Tax Statement, from each of your employers for use in preparing your federal tax return. Employers must furnish this record of 2006 earnings and withheld taxes no later than January 31, 2007 (if mailed, allow a few days for delivery).

If you do not receive your Form W-2, contact your employer to find out if and when the W-2 was mailed. If it was mailed, it may have been returned to your employer because of an incorrect address. After contacting your employer, allow a reasonable amount of time for your employer to resend or to issue the W-2.

If you still do not receive your W-2 by February 15th, contact the IRS for assistance at 1-800-829-1040. When you call, have the following information handy:

• The employer's name and complete address, including zip code, the employer’s identification number (if known), and telephone number,
• Your name and address, including zip code, Social Security number, and telephone number; and
• An estimate of the wages you earned, the federal income tax withheld, and the dates you began and ended employment.

If you misplaced your W-2, contact your employer. Your employer can replace the lost form with a “reissued statement.” Be aware that your employer is allowed to charge you a fee for providing you with a new W-2.

You still must file your tax return on time even if you do not receive your Form W-2. If you cannot get a W-2 by the tax-filing deadline, you may use Form 4852, Substitute for Form W-2, Wage and Tax Statement, but it will delay any refund due while the information is verified.

If you receive a corrected W-2 after your return is filed and the information it contains does not match the income or withheld tax that you reported on your return, you must file an amended return on Form 1040X, Amended U.S. Individual Income Tax Return.

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Deduction for Educator Expense

If you are an eligible educator, you may be able to deduct up to $250 of expenses you paid for purchases of books and classroom supplies. These out-of-pocket expenses may lower your 2006 tax bill even if you don’t itemize your deductions.

• Eligible Educator: The deduction is available if you are an eligible educator in a public or private elementary or secondary school. To be eligible, you must work at least 900 hours during a school year as a teacher, instructor, counselor, principal or aide.
• Qualifying Expenses: You may subtract up to $250 of qualified expenses when figuring your adjusted gross income. Qualified expenses are unreimbursed expenses you paid or incurred for books, supplies, computer equipment (including related software and services) and supplementary materials that you use in the classroom. For courses in health and physical education, expenses for supplies are qualified expenses only if they are related to athletics.

To be deductible, the qualified expenses must be more than the interest on qualified U.S. savings bonds that you excluded from income because you paid qualified higher education expenses, any distribution from a qualified tuition program that you excluded from income, and any tax-free withdrawals from your Coverdell Education savings account.

Call us for more information on Educator Expenses, or see IRS Publication 17, Your Federal Income Tax, under Chapter 19, Education Related Adjustments.

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Financial Planning Tips for February 2007

Review Your Savings Plan

Establish or review your savings plan to begin accumulating assets for your life goals. Professional guidance will be helpful in reviewing investment alternatives.

Review Your Retirement Plan

Establish or review your retirement plan. Explore the availability of deferred compensation programs through your employer, such as 401(k) and 403(b) plans. Begin contributing as soon as you are eligible.

Review January's Budget vs. Actuals

Compare January income and expenditures with your budget. Make adjustments as appropriate to your February expenditures. Make sure you have invested your planned savings amount for January.

Collect Your Tax Information

Verify that you have received all necessary forms W-2 and 1099 and a statement showing the year-end balance of IRA and Keogh plans. Contact the appropriate company for any that have not been received. For those that have been received, make certain that the amounts agree with your records.

Although taxes for personal returns are not due until April 15, it is best to get an early start since additional follow-up may be necessary.

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