Article: Congressional “Refinements” to the Charitable Deduction Rules

December 2006

Congressional “refinements” to the charitable deduction rules

Cash contributions and deductions/credits related to hybrid vehicles have become more complicated

Within the depths of the massive pension legislation enacted this year, Congress took the opportunity to adjust a number of rules affecting charitable contributions and certain tax credits. This article discusses two of the rule changes that may be of particular interest to you.

Contributions

Cash contributions. In a surprising development, federal law now imposes a zero-tolerance policy with respect to contributions and requires that all contributions of cash, regardless of amount, be substantiated via bank record (such as a canceled check or credit card charge) or supported by a receipt from the charity that indicates the charity name and the date and amount of the contribution. This rule is not effective until the 2007 tax year.

Example. Jed and Sue attend weekly church services and normally contribute $20 in cash. In the past, with careful notations of these cash contributions, they would have been allowed to include them in their charitable deductions. However, starting January 1, 2007, to claim a deduction Jed and Sue will need to issue a check for these contributions or obtain a receipt from the church.

Non-cash contributions. The new laws affect a number of non-cash contribution issues. (See our September 2006 article on the 2006 Pension Protection Act.) Among those issues are conservation easements and appraisal rules.

Conservation easements. In general, a charitable contribution is not allowed for donating a partial interest in real estate. However, a special rule allows conservation easements to qualify for charitable deductibility, provided that the donor retains underlying title. A typical conservation easement is accomplished by placing a perpetual restriction on the property, in conjunction with a charity or public entity, that assures the property will not be developed. The donor is allowed a charitable deduction equal to the diminished value.

To encourage a greater number of conservation contributions, Congress offered two incentives. Previously, a taxpayer’s deduction for a qualified conservation contribution was limited to 30% of annual income, with any excess contribution limited to a five-year carry-forward. The new law allows up to 50% of income to be offset by these contributions, with any excess contribution eligible for a 15-year carryover.

In the case of farmers and ranchers, the 50% income limit is enhanced to 100%, with this privilege also applying to incorporated farms and ranches that place real estate in a qualified conservation easement. These changes are effective for tax years beginning in 2006.

Appraisal rules. The IRS has existing regulations regarding requirements for appraisals of appreciated property that is the subject of a charitable contribution. Congress has significantly tightened those rules by making several changes. The tax law now contains a higher standard for the definition of an individual who serves as a qualified appraiser for charitable tax deduction purposes. In addition, Congress has added a new penalty that applies to persons who prepare an appraisal for charitable purposes that involves a substantial or gross valuation error. Finally, the taxpayer penalties on claiming a charitable deduction with a significant valuation error have been broadened. These changes were all effective as of August 18, 2006.

Hybrid vehicle credits

It used to be fairly simple. If you purchased a hybrid vehicle (one burning both gasoline and also propelled by electricity), you were entitled to claim a $2,000 deduction in your tax return. But that system ended with the 2005 tax year, and, beginning in 2006, we have a more complicated credit system that applies to hybrid vehicles and other energy-efficient vehicles sold by manufacturers. Given the confusion in the marketplace about these credits, we believe that a few words of advice and explanation are important.

The credit amount. The tax credit amount varies with the vehicle make and model. A manufacturer certifies the energy savings with the IRS, under a complicated formula that produces a specific credit amount that is assigned to the vehicle. This tax credit can vary significantly, from a low of $250 (Chevrolet Silverado hybrid two-wheel drive) up to $3,150 (Toyota Prius).

But there is further complexity. The tax rules limit the available credit to the first 60,000 qualifying vehicles sold in the U.S. by the manufacturer. Once that point is reached, the credit amount goes into a phase-down based on the date of acquisition.

For calendar year 2006, all of the hybrid vehicles qualify for 100% of their certified credit amount, with the exception of Toyota and Lexus models. Effective for vehicles purchased October 1, 2006, through March 31, 2007, those vehicles receive only 50% of their stated credit. And from April 1 through September 30, 2007, only 25% of the credit applies, with no credit after September 30, 2007. So, by way of illustration, if a taxpayer purchases a Toyota Prius in December 2006, the credit is 50% of the $3,150 certified amount, or $1,575.

Other complexities. Unfortunately, this hybrid tax credit only offsets regular income tax; it is not available to reduce AMT. The hybrid credit can reduce regular tax only to the point that it reaches AMT. Middle and upper income filers often have only a small gap between their regular tax and AMT, effectively limiting the benefit from this credit.

Businesses that purchase a hybrid vehicle will also receive the credit, but the credit amount must be treated as a reduction in the depreciable basis of the vehicle, and this has the effect of diminishing the value of the credit.

In terms of claiming the new hybrid credit in 2006 tax returns, we simply need to know the make and model of your purchased hybrid vehicle and the date it was acquired. No certification or other documentation is required.

And finally, there is no tax benefit for vehicles that burn both regular fuel and E 85 (ethanol fuel). Congress has chosen to encourage the production of ethanol by offering tax credits for the producers of the fuel, rather than a credit for acquisition of the vehicle itself.

Based in Mesa, Arizona, and serving closely held businesses in the East Valley, the Phoenix area and throughout Arizona, Schmidt Westergard & Company, PLLC, is an independent full-service tax, audit, accounting and business advisory firm focusing on the middle market.