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     - Winter '05

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Katrina Tax Incentives for 2005

          On September 23, 2005, in response to the hurricane disasters that hit the Gulf Coast, Congress passed and President Bush signed into law the Katrina Emergency Tax Relief Act of 2005 (KETRA). This law was enacted to accomplish two goals: first, to provide temporary tax relief to the victims of this year’s Gulf Coast hurricanes; and, second, to provide incentives for other individuals to make charitable cash donations to public charities between August 28, 2005 and December 31, 2005. For charitable donors, KETRA provides two significant tax incentives. First, it increases from 50% to 100% the amount of charitable contributions taxpayers may deduct from their adjusted gross income. Second, it excludes charitable contributions from the 3% phase-out of itemized deductions that certain taxpayers may be subject to. KETRA applies to cash contributions only and does not require that those contributions be made for Hurricane Katrina-related relief. So, individuals who are charitably inclined this year may now deduct 100% of their charitable cash contributions before January 2006.

Law Before KETRA

          The tax law before KETRA (and as will be the case again after December 31, 2005) only allowed taxpayers to deduct up to 50% of certain charitable contributions from their adjusted gross income. Any contributions that exceeded that 50% limit could be carried forward for up to five years. Donations of appreciated capital gains property (e.g. appreciated securities) and donations to private foundations and certain other organizations could only be deducted up to 30%. Additionally, for individual taxpayers whose adjusted gross income exceeded $145,950 ($218,950 for married couples filing a joint return; or $72,975 for married couples filing separate returns) in 2005, their itemized deductions, including charitable contributions were reduced on a sliding scale from 3% to 80%.

Law After KETRA

Increased Limits on Charitable Cash Contributions

          Congress has temporarily increased the deductibility limit on certain charitable contributions. A taxpayer may now deduct “qualified contributions” made between August 28, 2005 and December 31, 2005 up to the amount the contributions exceed the taxpayer’s contribution base (i.e. adjusted gross income before net operating loss carryback). In most cases, this means that charitable cash contributions are deductible up to 100% of a taxpayer’s adjusted gross income. Qualified contributions under KETRA include cash donations to most public charities but exclude non-cash donations or donations to private foundations. Like before KETRA, donations that exceed the maximum deductibility (under KETRA, 100% of adjusted gross income) can be carried forward to succeeding years. In other words, even under KETRA, the Internal Revenue Service will still not allow a taxpayer to take a net loss simply by making a larger-than-adjusted gross income charitable contribution in 2005. But, the short-term benefit of being able to potentially deduct 100% of charitable cash contributions up to the full amount of adjusted gross income is significant and ought not to be overlooked.

Suspended Phase-out for Itemized Deductions

          Congress has temporarily allowed certain high-income taxpayers to exclude “qualified
contributions” from the itemized deduction phase-out. Under KETRA, and only for the 2005 tax year, qualified contributions will not be subject to the 3% phase-out of itemized deductions under Internal Revenue Code Section 68. The phase-out still applies to other itemized deductions, but all qualified contributions are excluded from the phase-out and remain deductible on a dollar-for-dollar basis up to 100% of adjusted gross income.

          KETRA also permits certain early individual retirement account withdrawals without penalty if the withdrawals are given away as qualified contributions. But, taxpayers who choose to do this should be wary. These withdrawals may increase a taxpayer’s adjusted gross income even though that increase may be offset by the 100% deductibility of qualified contributions. But, that increase in adjusted gross income may still significantly impact the taxpayer’s ability to take other 3% itemized deductions and may also increase the taxpayer’s state and local tax liability. Any taxpayer who chooses to make an early IRA withdrawal for qualified contributions this year should consult his or her tax advisor first. Certain other benefits may be available under KETRA that include tax credits for housing Katrina evacuees or donating one’s vacation time. A whole host of other provisions specifically targeted to individuals directly affected by Hurricane Katrina are available under KETRA, as well.

          Pursuant to Internal Revenue Service guidance, be advised that any federal tax advice in this communication, including any attachments or enclosures, was not intended or written to be used, and cannot be used, by any person or entity for the purpose of avoiding penalties imposed under the Internal Revenue Code. This document does not constitute legal advice or a legal opinion on any specific facts or circumstances. The contents are intended as general information only. You are urged to consult your own lawyer or tax professional concerning your situation and any specific legal or tax questions that you may have.

          If you have additional questions regarding KETRA or if desire our assistance in advising you or your organization regarding tax, general business or real estate matters, please contact William J. Hawkins, Chair of the Business Practice Group, at (312) 346-6019.