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From charity donations to 401(k)s, pension law has it: Still must itemize to get credit

Aug. 20, 2006--Put a $5 bill in the church collection plate, give a pair of pants to Goodwill or plan retirement savings, and your actions will be changed by the massive Pension Protection Act of 2006 signed Thursday by President Bush.

The new law, designed primarily to make sure that traditional pension plans are adequately funded, contains a number of other provisions that will have a more immediate impact on the average American.

For example, in the new law "Congress poses the question, 'How many holes in your underwear make it a non-deductible charitable contribution?' " according to Jack B. Siegel, author of the Charity Governance Blog.

The reason for his query: Under the new law, only the value of clothing and household items in "good condition" can be deducted as a charitable gift. It is left up to the Internal Revenue Service to define exactly what "good condition" is, and the answer will mean a lot of dollars and cents to Uncle Sam.

In 2003, the most recent year for which data are available, Americans claimed deductions for about $17.7 billion worth of donated clothing, according to CCH, a tax information service in Riverwoods, Ill.

"Given the distressed jeans you see in stores nowadays, how do you say what is in 'good condition?' " asked Bob Scharin, a senior tax analyst for RIA, a tax information firm in New York City.

The best advice -- start to keep much more detailed records of donated items, even to the point of taking pictures.

The new law also says that in order to deduct a donation made by cash or check, the donor must show a bank record or written communication from the charity indicating the amount, date and name of the charity. So the $5 in the church plate will need a receipt, or Uncle Sam will disallow it.

Experts suggest making such donations by check as a way to start a paper trail. But even so, "charities will likely be spending more time and money on administrative duties to make sure that every taxpayer who wants a receipt receives one," CCH notes in a briefing on the matter.

Another caveat -- even though a number of members of Congress wanted to end the requirement, the law still requires that a person itemize deductions to get credit for charitable gifts.

One place the new law's sections on charity and retirement savings overlap is a provision on withdrawals from individual retirement accounts by people over 70 1/2 .

Such folks are required to make withdrawals, on which they must pay taxes.

However, until Dec. 31, 2007, the new law allows them to donate up to $100,000 from such an IRA directly to a charity without it counting as income. The tradeoff is that they cannot take a deduction for the gift.

That obviously helps people who would not itemize, Scharin said. But it also is a way for people to make sure that they don't have so much extra income that more of the Social Security payments are taxed, points out Jim Brandenburg, a certified public accountant with Kolb Co., Brookfield.

Determining whether to make contributions directly or from an IRA will require some individual planning, he said.

The rule is among a number of changes in the law designed to make it easier for people to fund and move money among the universe of IRAs, Roth IRAs, 401(k)s and similar retirement savings plans. For example, starting next year, tax refunds can be deposited directly into an IRA.

Most of the rest of the provisions will not take effect for several years.

"The effective dates on some of these provisions are all over the board, you need to really review that," Brandenburg said.

The new law also makes it easier, and indeed encourages, employers to automatically enroll new workers in 401(k) plans, although it gives workers the ability to opt out with no penalty within 90 days. It also makes it much easier for investment companies to give individualized advice to workers about the best place to put their 401(k) money.

"The aim is pretty clear: To try to give people the fewest excuses possible for not putting their money into some retirement vehicle," said Nicholas Kaster, senior pension analyst for CCH.

One way the new law does this is by making permanent several provisions of the Economic Growth and Tax Relief Reconciliation Act of 2001 that were set to expire in 2011. The act is the signature tax cut legislation of the Bush administration.

Those changes include:

-- Higher contribution limits for IRAs, including catch-up contributions for workers 50 and older.

-- Creation of Roth 401(k)s and 403(b)s.

-- The saver's credit of up to $2,000 for contributions to retirement plans by lower-income individuals.

The law also makes permanent college savings plans, such as EdVest in Wisconsin. They were set to expire in 2011.

The new law leaves many loose ends, among them whether Wisconsin will adopt the changes as part of its tax code. Most would require a change in state law, and the Wisconsin Department of Revenue is still studying what to recommend, said Meredith Helgerson, spokeswoman for the department.

"I don't think that this law can be billed as simplification," Kaster said.

Because so many of its provisions overlap with each other and previous laws it "is going to spawn years of regulations, ruling and other guidance by the IRS," he said. "That is one thing I can state with complete confidence."

Milwaukee Journal Sentinel, The (KRT) via NewsEdge Corporation :