The Pension Protection Act of 2006 was signed by the President on August 17, 2006. Although the Act does, as its name implies, provide many new provisions “protecting pensions,” it also contains many other provisions affecting individuals and charities. Following is a brief overview of a few of the new provisions that will effect many taxpayers and charities.
Rollover of Eligible Retirement Plan Distributions to Roth IRA. Beginning in 2008, qualified rollover distributions from a qualified retirement plan, tax sheltered annuity, or governmental 457 plan can be made directly to a Roth IRA. The rollover requirements of the specific plan must be satisfied, and the taxpayer’s adjusted gross income may not exceed $100,000 in years before 2010. Before this change, a two-step process was required. The taxpayer would first be required to rollover the distribution to a traditional IRA and then elect Roth treatment for the traditional IRA. Note, beginning in 2010, all taxpayers are eligible to convert a traditional IRA to a Roth IRA. Prior to 2010, only taxpayers with adjusted gross income below $100,000 are eligible. This change was enacted by the Tax Increase Prevention and Reconciliation Act of 2005.
Rollover of Qualified Plan Distributions by a Non-Spouse Beneficiary to an IRA. Many employer sponsored plans require the immediate distribution of the account balance in a lump sum after the employee or former employee’s death. Prior law only allowed a surviving spouse beneficiary to rollover such a distribution to an IRA and take distributions over time under the minimum distribution rules. Beginning in 2007, the Pension Protection Act will allow nonspouse beneficiaries (including trusts) to rollover a qualified plan distribution to an IRA established in the decedent’s name. Distributions from the rollover IRA are then permitted to be made as slowly as permitted under the minimum distribution rules.
IRA distributions to Charities. For the remainder of 2006 and for calendar year 2007, individuals who have attained the age 701⁄2 may distribute a maximum of $100,000 from an IRA (including a Roth IRA) to a charity without the distribution being included in the taxpayer’s income. A charitable deduction is not allowed, since the distribution is not included in the taxpayer’s income. Even though the distribution is excluded from the taxpayer’s income, the distribution counts toward the minimum distribution required for the taxpayer. This treatment will be preferred for many taxpayers who can take advantage of it, because normally a distribution from an IRA must be included in income, and then an itemized deduction may be permitted for the contribution to charity. However, due to the phase-out of itemized deductions and the adjusted gross income limitation on charitable deductions, a deduction often does not place the taxpayer in the same position as excluding the distribution from income.
Contributions of Clothing and Household Items to Charities. Deducting contributions of clothing and household items to charities will now be more limited. For contributions made after August 17, 2006, a deduction is allowed only for contributions of clothing or household items if the items are in “good used condition or better.” There is an exception for any item that is valued at more than $500 if a qualified appraisal is obtained and filed with the tax return on which the deduction is claimed.
Contributions of Cash to Charities: New Record Keeping Requirements. Effective for tax years beginning after August 17, 2006, in order for a deduction to be allowed for a contribution of any amount to a charity of cash, a check, or other monetary gift, it must be evidenced by a bank record or a receipt, letter or other written communication from the donee (indicating the name of the donee organization, the date the contribution was made, and the amount of the contribution). This is a substantial change from the prior law which had a “de minimus” exception that did not require the taxpayer to obtain a bank record or receipt for any contribution of cash to a charity that did not exceed $250.
Pension and IRA Provisions of EGTRRA Made Permanent. The Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA) contained numerous provisions relating to pension plans and IRAs benefiting taxpayers that were set to expire or “sunset” on December 31, 2010. The Pension Protection Act of 2006 removed the sunset provisions for the pension and IRA provision of EGTRRA including making permanent the following provisions:
- Defined Contribution Plan Contribution Limits: The maximum contribution on behalf of a participant in a Defined Contribution Plan (that includes Profit Sharing and Money Purchase Pension Plans) is $44,000 for 2006 and is indexed for inflation.
- Defined Contribution Plan “Compensation”: In 2006, the maximum compensation that can be utilized to determine a person’s benefits is $220,000. This amount is also indexed for inflation.
- Maximum deferral for 401(k), 403(b), 457(b) and 408(k) SEP Plans: The maximum amount of compensation that can be deferred under these plans is $15,000. This maximum is indexed for inflation.
- Maximum deferral for SIMPLE Accounts: For 2006, the maximum deferral is $10,000 which is indexed for inflation in future years.
- “Catch Up” Contributions for Individuals age 50 or over: Individuals who have attained age 50 are allowed to make an additional contribution of up to $5,000 to 401(k), 403(b), 457(b) and SEP Plans. An additional contribution of up to $2,500 is allowed to SIMPLE Plans. Both amounts are indexed for inflation.
- IRA Contribution Limits: For 2006 and 2007, the maximum contribution to an IRA that is deductible is $4,000.00. The deductible amount is $5,000 for 2008 and is adjusted for inflation for years after 2008. A catch up distribution of $1,000 is allowed to be made to IRAs for individuals who have attained the age of 50. This catch up distribution is not indexed for inflation.
Section 529 Plans – Qualified Tuition Programs: The Pension Protection Act permanently extends the favorable changes to Section 529 Plans made by the Economic Growth and Tax Relief Reconciliation Act of 2001. The major advantage made by EGTRRA was to exclude distributions from federal income to the extent used to pay the qualified higher education expenses of the beneficiary. These modifications were to expire on December 31, 2010. The Pension Protection Act permanently extends the favorable provisions, but also grants the IRS the authority to enact regulations necessary to carry ou the purposes of Section 529 Plans (i.e., save for the higher education expenses of the beneficiary) and prevent abuses. Thus, more rules regarding the plans may be imposed in the future.