Three Planning Gems Contained in The Pension Protection Act of 2006

Three Planning Gems Contained in The Pension Protection Act of 2006

After a brief review of the status of estate tax repeal legislation, this FaxAlert will examine the Pension Protection Act, which Congress passed and the President signed into law on August 17, 2006. On June 6, the Senate vote for full repeal of the estate tax fell three votes short of the 60 required votes. Having failed to get full repeal, the House compromised and was able to pass a bill that would have raised the amount that can pass free of estate tax to $5 million and would have lowered the estate tax rate to be equal to the capital gain tax rate. On August 3, this Bill was voted on by the Senate and it too failed to get the sixty votes required, 56-42. On July 28, the House passed a second Bill, 230-180, that would have raised the applicable exclusion amount from $3.75 million to $5 million between 2010 and 2015 and would have lowered the estate tax rate to the capital gain rate for estates of $25 million or less and twice the capital gain rate for estates over $25 million. That Bill has not been voted on by the Senate. The Senate leadership has indicated they intend to revisit estate tax reform one more time before the elections, but it appears they will not be able to muster the necessary votes for passage unless the Senate Republicans are willing to settle for a lower applicable exclusion amount, perhaps $3 million – $3.5 million, and a higher estate tax rate, probably in the 30% to 45% range.

Pension Protection Act of 2006 (“the Act”)
Within the 907 pages of legalese that make up the Act can be found three sparkling gems that will be of benefit to your clients.

Charitable IRA. After extensive lobbying by charitable organizations for the past four years, the Act contains a provision for a Charitable IRA. In 2006 and 2007 only, taxpayers who are age 70 ½ or older can make distributions directly from their IRA to a qualified charity and that distribution would not be counted as taxable income to the taxpayer. The distributions to the charity can even include the 2006 or 2007 Required Minimum Distribution that the taxpayer would have had to withdraw from the IRA in any event. The maximum distribution to the charity is $100,000 per year. The distribution must come from pre-tax money and it is limited only to distributions from an IRA. SEPs, SIMPLE, 401(k), 403(b), Profit Sharing and other qualified retirement plans will not be eligible for treatment as a Charitable IRA. While the distribution to the charity does not qualify for a charitable income tax deduction, none of the income associated with the distribution is reported on the taxpayer’s income tax return. For taxpayers with substantial IRAs and a desire to benefit charity, this opportunity to make lifetime gifts from an IRA to a charity without worrying about the income tax ramifications should not be missed!

Conservation Easements. Conservation easements are a planning technique whereby the owner of property imposes an easement on the property that limits its future development potential. The easement is typically donated to a nature conservancy or other environmental charity and the donor receives three potential benefits: (1) the present use of the property is preserved for the donor’s family in perpetuity, (2) the value of the property for estate tax purposes is reduced, and (3) the donor can receive a charitable income tax deduction for the value of the easement which is being donated to the charity.

The Act significantly increases the deduction for donations of conservation easements for 2006 and 2007. For those two years, the Act eliminates the 30% of Adjusted Gross Income (“AGI”) limitation on contributions of capital assets to a charitable organization and increases the deduction limitation for conservation easements to 50% of AGI. The Act further extends the limit to 100% of AGI (or taxable income in the case of a corporation) if the taxpayer donor is a qualified farmer or rancher – as long as the property on which the easement is donated will be “available” for farming or ranching. And unlike the limit of 5 years carry-forward of charitable deductions for ordinary charitable contributions, this special contribution will be allowed a carry-forward of the charitable deduction for up to 15 years.

Non-Spousal Rollovers. Perhaps the most significant and least talked about change brought about by the Act is the provision dealing with non-spousal rollovers starting in 2007. Under current law, only the spouse can rollover retirement assets after the death of a retirement plan owner. This can create problems, especially for domestic partners. Many company retirement plans have provisions that when retirement benefits are paid to a non-spouse beneficiary, such as a domestic partner, child, or a trust, the retirement plan must be paid out or terminated within a relatively short time period, such as one to five years. One of the most common reasons that companies place these types of restrictions in their retirement plans is to reduce the time and costs associated with managing retirement assets for non-employees.

The problem is that these types of provisions prevent a beneficiary under the retirement plan from taking withdrawals over his or her life expectancy and thereby the amount of benefits received and deferring income taxation for the longest period possible. Because these restrictions are often buried somewhere deep within the retirement plan custodial agreement, they are often not discovered until after the retirement plan owner has died and the beneficiary is being forced to take a distribution from the retirement plan. Experts say the rule, which takes effect next year, could save many beneficiaries tens of thousands of dollars in income taxes. Joe Solmonese, president of the Human Rights Campaign, a gay civil rights organization, stated: “I think it’s incredibly significant, and I think it’s historic. What we really are seeing here, I think, is a huge step toward leveling the field.” Beginning in 2007 a child, domestic partner, trust or other non-spouse beneficiary of a qualified retirement plan with one of these restrictive provisions will be able to transfer funds from the inherited qualified plan to an inherited IRA established with another custodian. This will allow beneficiaries who were previously left without any options, other than to take the distribution and pay the associated tax, the ability to continue to defer taking distributions for the maximum time period allowed under the law. To the extent that a non-spousal beneficiary is faced with the situation currently, it would be beneficial to delay taking any distributions to 2007, if possible.