The New Pension Reform Law Affects Every Church

Article summary. In August Congress enacted the most comprehensive pension reform legislation in over 30 years. While the massive Pension Protection Act of 2006 is designed primarily to provide added security to employees enrolled in pension plans, it also addresses additional issues that affect church leaders, including some that will impact charitable contributions made to churches. Church leaders need to be familiar with these provisions. This article explains the provisions in the new law that are of most importance to churches, and illustrates them with examples.

Congress enacted a massive new 900-page pension reform bill designed to strengthen pension plans and reduce the need for taxpayer-funded bailouts of failed plans. While the main focus of the ‘Pension Protection Act of 2006’ is pension reform, the Act also includes a number of unrelated provisions of direct relevance to every church. Most notably, the Act imposes new requirements on the substantiation of charitable contributions. These requirements take effect immediately, and affect contributions made to churches.

In summary, this Act affects nearly everyone, since it applies to the millions of Americans enrolled in pension or retirement plans, as well as persons who make charitable contributions to churches or charities.

This article focuses on those provisions in the new law that are of greatest relevance to church leaders. We will begin by focusing on the provisions that apply to charities and charitable contributions, and then address the retirement provisions.

The Pension Protection Act contains charitable giving incentives designed to encourage charitable donations. Here are the main provisions of interest to church leaders.

1. Tax-free distributions from IRAs for charitable purposes

The Pension Protection Act of 2006 allows tax-free ‘qualified charitable distributions’ of up to $100,000 from an IRA to a church or other charity. Note the following rules and conditions:

2. Charitable deduction for contributions of food inventory

A taxpayer’s deduction for charitable contributions of inventory generally is limited to the taxpayer’s basis (cost) in the inventory, or if less, the fair market value of the inventory. For certain contributions of inventory, ‘C corporations’ may claim an enhanced deduction equal to the lesser of (1) basis plus one-half of the item’s appreciation (i.e., basis plus one half of fair market value in excess of basis) or (2) two times basis. In general, a C corporation’s charitable contribution deductions for a year may not exceed 10 percent of the corporation’s taxable income.

To be eligible for the enhanced deduction, the contributed property generally must be inventory of the taxpayer, contributed to a charitable organization, and the charity must (1) use the property consistent with its exempt purpose solely for the care of the ill, the needy, or infants, (2) not transfer the property in exchange for money, other property, or services, and (3) provide the taxpayer a written statement that the charity’s use of the property will be consistent with such requirements.

Under the Katrina Emergency Tax Relief Act of 2005, any taxpayer engaged in a trade or business is eligible to claim the enhanced deduction for certain donations made after August 28, 2005 and before January 1, 2006, of food inventory. In other words, the enhanced deduction is not limited to C corporations. However, the total deduction for donations of food inventory in a given year generally may not exceed 10 percent of a taxpayer’s net income from all business entities from which contributions of ‘apparently wholesome food’ were made. ‘Apparently wholesome food’ is defined as food intended for human consumption that meets all quality and labeling standards imposed by federal, state, and local laws and regulations even though the food may not be readily marketable due to appearance, age, freshness, grade, size, surplus, or other conditions.

The Pension Protection Act extends the provision enacted as part of the Katrina Emergency Tax Relief Act of 2005. Any taxpayer, whether or not a corporation, engaged in a trade or business is eligible to claim the enhanced deduction for donations of food inventory. The total deduction for donations of food inventory in a given year generally may not exceed 10 percent of the taxpayer’s net income for such taxable year from all business entities from which contributions of apparently wholesome food are made.

This provision is effective for contributions made after December 31, 2005, and before January 1, 2008.

The Pension Protection Act of 2006 contains a charitable reform package designed to responsibly regulate exempt organizations. Here are the main provisions of interest to church leaders.

1. Modification of recordkeeping requirements for cash contributions

Caution. The Pension Protection Act of 2006 changes the way that donors substantiate cash contributions to a church or charity. Church leaders must be familiar with these new rules to ensure that members will be able to deduct their cash contributions. The new rules took effect upon enactment of the Act on August 17, 2006.

A donor who claims a deduction for a charitable contribution must maintain reliable written records regarding the contribution, regardless of the value or amount of the contribution.

Prior to enactment of the Pension Protection Act of 2006, donors could substantiate a cash contribution to a church or charity with any one of the following:

As noted below, the Pension Protection Act of 2006 changes the way that cash contributions are substantiated.

For a contribution of property other than money, the donor generally must maintain a receipt from the donee charity showing the name of the donee, the date and location of the contribution, and a detailed description (but not the value) of the property. A donor of property other than money need not obtain a receipt, however, if circumstances make obtaining a receipt impracticable. Under such circumstances, the donor must maintain reliable written records regarding the contribution. The required content of such a record varies depending upon factors such as the type and value of property contributed.

In addition to the foregoing recordkeeping requirements, substantiation requirements apply in the case of individual charitable contributions with a value of $250 or more. No charitable deduction is allowed for any contribution of $250 or more unless the taxpayer substantiates the contribution by a contemporaneous written acknowledgement of the contribution from the donee organization. Such acknowledgement must include the amount of cash and a description (but not value) of any property other than cash contributed, whether the donee provided any goods or services in consideration for the contribution, and a good faith estimate of the value of any such goods or services. In general, if the total charitable deduction claimed for non-cash property is more than $500, the taxpayer must attach a completed Form 8283 (Noncash Charitable Contributions) to the taxpayer’s return or the deduction is not allowed. In general, taxpayers are required to obtain a qualified appraisal for donated property with a value of more than $5,000, and to attach an appraisal summary to the tax return (Form 8283, Section B).

The rules for substantiating contributions of noncash property were not affected by the Pension Protection Act of 2006. However, the Act made an important change in the way that contributions of cash are substantiated. It amended the tax code to require all cash contributions, regardless of amount, to be substantiated by either a bank record (such as a cancelled check) or a written communication from the donee showing the name of the donee organization, the date of the contribution, and the amount of the contribution. The recordkeeping requirements may not be satisfied by maintaining other written records. In the past, donors could substantiate cash contributions of less than $250 with ‘other reliable written records showing the name of the donee, the date of the contribution, and the amount of the contribution’ if no cancelled check or receipt was available. This is no longer allowed.

As noted above, additional substantiation requirements apply to individual contributions (of cash or property) of $250 or more, and these must be satisfied as well.

This change is effective for contributions made in taxable years beginning after the date of enactment.

2. Reduction in charitable contribution deduction for appreciated tangible personal property not used for charitable purposes

‘Tangible personal property’ is any property, other than land or buildings, that can be seen or touched. It includes such items as furniture, antiques, books, jewelry, stamp or coin collections, equipment, computers, vehicles, clothing, and works of art. In most cases such property ‘depreciates’ over time, meaning that its market value is less than what the owner paid for it (the property’s ‘basis’). It is common for persons who own tangible personal property that has decreased in value to donate the property to their church or favorite charity. In such cases, the amount of the charitable contribution deduction is the fair market value of the donated property at the time of the contribution, and not the property’s cost basis.

Some tangible personal property may increase in value over time. This is called appreciation. Generally, the amount of a charitable contribution deduction for a donation of appreciated tangible personal property to a church or charity is the property’s fair market value at the time of the contribution, and not the cost basis. In other words, the donor gets to deduct not just the cost basis of the donated property, but also the amount the property has increased in value. But, there is an important exception to this rule. The tax code specifies that the amount of a charitable contribution deduction for a donation of appreciated tangible personal property that is not used by the church or charity for a ‘purpose or function constituting the basis for its [tax] exemption … shall be reduced by the amount of gain which would have been long-term capital gain if the property contributed had been sold by the taxpayer at its fair market value (determined at the time of such contribution).’ This generally means that the amount of the charitable contribution deduction will be reduced to the property’s ‘cost basis’ (what the donor paid for it). But, so long as the church or charity uses the donated property in a way that is directly related to its exempt purposes, the donor generally may claim a charitable contribution deduction in the amount of the property’s fair market value.

Under prior law, if a charity sold or otherwise disposed of donated property (including tangible personal property) with a claimed value of more than $5,000 (other than publicly traded securities) within two years of the contribution, it was required to file an information return (Form 8282) with the IRS and furnish a copy to the donor showing the name, address, and taxpayer identification number of the donor, a description of the property, the date of the contribution, the amount received on the disposition, and the date of the disposition.

The Pension Protection Act of 2006 made the following changes to these rules:

Prior to enactment of the Pension Protection Act of 2006, churches and other charities were required to file Form 8282 with the IRS if they disposed of certain donated noncash property within two years of the date of contribution. This requirement applied to donated property (other than money or certain publicly traded securities) for which the donee charity signed, or was asked to sign, the Appraisal Summary (Form 8283, Section B) pertaining to donated noncash property valued at more than $5,000. IRS Form 8282 will have to be modified in the following three ways:

3. Fines and penalties applicable to charitable organizations

Under prior law, the IRS could assess a penalty against ‘managers’ of a church or other charity who approve an ‘excess benefit transaction’ unless a manager can demonstrate that his or her approval was ‘not willful and due to reasonable cause.’ This penalty was in the form of an excise tax of up to 10% of the amount of the excess benefit, with a maximum of $10,000 per manager (but the total tax on all directors cannot exceed $10,000).

The Pension Protection Act of 2006 increases the 10% amount to 20%. It also doubles the dollar limitation on managers for participation in excess benefit transactions from $10,000 per transaction to $20,000 per transaction.

4. Clothing and household items

Americans love to donate used clothing and household items to charity. The IRS reports that the amount claimed as deductions in a recent year for clothing and household items was more than $9 billion! These items are notoriously difficult for the IRS to value, and the attempt to do so wastes valuable time and resources that could better be directed on other matters.

The Pension Protection Act of 2006 responds to these concerns by amending the tax code to deny a charitable contribution deduction for a contribution of clothing or household items unless the clothing or household items are in ‘good used condition or better.’ The Treasury Department is authorized to deny (by regulation) a deduction for any contribution of clothing or a household item that has minimal monetary value, such as used socks and used undergarments.

Under the new provision, a deduction may be allowed for a charitable contribution of an item of clothing or a household item not in good used condition or better only if the amount claimed for the item is more than $500 and the taxpayer includes with his or her tax return a qualified appraisal with respect to the property. Household items include furniture, furnishings, electronics, appliances, linens, and other similar items. Food, paintings, antiques, and other objects of art, jewelry and gems, and collections are excluded from the provision.

This provision is effective for contributions made after August 17, 2006.

5. Appraisal reform

Prior to the Pension Protection Act of 2006, the tax code imposed ‘accuracy-related penalties’ on taxpayers in cases involving a ‘substantial valuation misstatement’ or ‘gross valuation misstatement’ relating to an underpayment of income tax. A substantial valuation misstatement generally meant a value claimed that was at least twice (200 percent or more) the amount determined to be the correct value, and a gross valuation misstatement generally means a value claimed that is at least four times (400 percent or more) the amount determined to be the correct value.

The penalty was 20 percent of the underpayment of tax resulting from a substantial valuation misstatement and rose to 40 percent for a gross valuation misstatement. No penalty was imposed unless the portion of the underpayment attributable to the valuation misstatement exceeded $5,000 ($10,000 in the case of a corporation). In addition, no penalty was imposed with respect to any portion of the understatement attributable to any item if (1) the treatment of the item on the return is or was supported by substantial authority, or (2) facts relevant to the tax treatment of the item were adequately disclosed on the return or on a statement attached to the return and there is a reasonable basis for the tax treatment. In addition, the accuracy-related penalties did not apply if a taxpayer could demonstrate that there was reasonable cause for an underpayment and the taxpayer acted in good faith.

The Pension Protection Act of 2006 lowers the thresholds for imposing accuracy-related penalties on a taxpayer. A substantial valuation misstatement exists when the claimed value of any property is 150 percent or more of the amount determined to be the correct value. A gross valuation misstatement occurs when the claimed value of any property is 200 percent or more of the amount determined to be the correct value. And, the ‘reasonable cause’ exception to the accuracy-related penalty does not apply in the case of gross valuation misstatements.

Taxpayers are required to obtain a qualified appraisal for donated property with a value of more than $5,000, and to attach an appraisal summary to their tax return. Treasury Regulations define a qualified appraisal as an appraisal document that, among other things: (1) relates to an appraisal that is made not earlier than 60 days prior to the date of contribution of the appraised property and not later than the due date (including extensions) of the return on which a deduction is first claimed; (2) is prepared, signed, and dated by a qualified appraiser; (3) includes (a) a description of the property appraised; (b) the fair market value of the property on the date of contribution and the specific basis for the valuation; (c) a statement that the appraisal was prepared for income tax purposes; (d) the qualifications of the qualified appraiser; and (e) the signature and taxpayer identification number of the appraiser; and (4) does not involve an appraisal fee that violates certain prescribed rules.

Treasury Regulations define a qualified appraiser as a person holding himself or herself out to the public as an appraiser or who performed appraisals on a regular basis, is qualified to make appraisals of the type of property being valued (as determined by the appraiser’s background, experience, education and membership, if any, in professional appraisal associations), is independent, and understands that an intentionally false or fraudulent overstatement of the value of the appraised property may subject the appraiser to civil penalties.

The Pension Protection Act of 2006 makes the following changes in the qualified appraisal requirement:

These changes generally apply after August 17, 2006.

6. Convention or association of churches

An organization that qualifies as a ‘convention or association of churches’ is not required to file an annual return (IRS Form 990), is subject to the church tax inquiry and church tax examination protections, and is subject to certain other provisions that generally apply to churches. The tax code does not define the term ‘convention or association of churches.’

The Pension Protection Act of 2006 amends the tax code to provide that an organization that otherwise is a convention or association of churches does not fail to so qualify merely because the membership of the organization includes individuals as well as churches, or because individuals have voting rights in the organization.

7. Public disclosure of information relating to unrelated business income tax returns

The Pension Protection Act of 2006 amends the tax code to make the annual unrelated business income tax return (Form 990-T) subject to public inspection. Such forms ‘shall be made available by such organization for inspection during regular business hours by any individual at the principal office of such organization and, if such organization regularly maintains one or more regional or district offices having three or more employees at each such regional or district office, and upon request of an individual made at such principal office or such a regional or district office, a copy of such return … shall be provided to such individual without charge other than a reasonable fee for any reproduction and mailing costs. The request … must be made in person or in writing. If such request is made in person, such copy shall be provided immediately and, if made in writing, shall be provided within 30 days.’

The new law specifies that certain information may be withheld by the organization from public disclosure and inspection if public availability would ‘adversely affect’ the organization.

Elimination of ‘Sunset’ Retirement Provisions

The Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA) made a number of changes to the tax code pertaining to pension plans and IRAs. However, EGTRRA included a ‘sunset’ provision under which all of these provisions expired at the end of 2010. The Pension Protection Act of 2006 makes these provisions permanent. Here are the main provisions that were scheduled to expire after 2010, and that were made permanent by the Pension Protection Act:

EGTRRA increased the maximum annual dollar contribution limit for IRA contributions from $2,000 to $3,000 for 2002 through 2004, to $4,000 for 2005 through 2007, and to $5,000 for 2008. After 2008, the limit is adjusted annually for inflation in $500 increments. In addition, individuals who have attained age 50 may make additional “catch-up” IRA contributions. The maximum contribution limit (before application of the ‘phase-out limits’ that apply to taxpayers with adjusted gross income above a specified amount) for an individual who has attained age 50 before the end of the taxable year is increased by $500 for 2002 through 2005, and $1,000 for 2006 and thereafter. Both the increased annual contribution limits and the special ‘catch up’ contribution option were scheduled to expire at the end of 2010. The Pension Protection Act makes both of these provisions permanent.

EGGTRA introduced the concept of ‘deemed IRAs.’ A qualified employer plan (including a 403(b) plan) may permit employees to make voluntary employee contributions to a separate account or annuity established under the plan. If the requirements of section 408(q) are met, such an account or annuity is treated in the same manner as an IRA, and contributions to such an account or annuity are treated as contributions to an IRA and not to the qualified employer plan. The account or annuity is referred to as a deemed IRA.

Deemed IRAs were scheduled to expire at the end of 2010, but the Pension Protection Act of 2006 makes them permanent.

EGGTRA substantially increased the amount that could be contributed to an employee’s 403(b) account. It amended the tax code to allow employees to contribute up to the lesser of (1) the limit on annual additions, or (2) the limit on elective deferrals.

The limit on annual additions is the lesser of 100% of includible compensation, or $40,000. The $40,000 amount is indexed for inflation, and in 2006 increased to $44,000.

The limit on elective deferrals specifies the maximum amount that an employee can contribute to his or her 403(b) account through salary reduction. Once again, EGGTRA substantially increased this amount from $10,000 to $11,000 in 2002. In 2003 and thereafter, the limit is increased in $1,000 annual increments until the limit reaches $15,000 in 2006, with indexing in $500 increments thereafter.

These two limits allow employees to contribute far more to their 403(b) account than was possible prior to the enactment of EGGTRA. They were scheduled to expire at the end of 2010, but were made permanent by the Pension Protection Act of 2006.

EGGTRA substantially increased the limit on elective deferrals under a 403(b) annuity for individuals who have attained age 50 by the end of the year by allowing them to make additional ‘catch up’ contributions to their account so long as no other elective deferrals may otherwise be made because of the application of any limitation of the tax code (e.g., the annual limit on elective deferrals) or of the plan itself. The additional amount of elective contributions that may be made by an eligible individual is the lesser of (1) the applicable dollar amount, or (2) the participant’s compensation for the year reduced by any other elective deferrals of the participant for the year. EGGTRA defined the applicable dollar amount under a 403(b) annuity as $1,000 in 2002, and increased it by $1,000 each year until it reached $5,000 in 2006. It is adjusted for inflation in future years. Catch-up contributions are not subject to any other contribution limits and are not taken into account in applying other contribution limits. In addition, such contributions are not subject to applicable nondiscrimination rules.

The generous catch up contribution limits introduced by EGGTRA were to expire at the end of 2010. However, they were made permanent by the Pension Protection Act of 2010.

EGGTRA allows a 403(b) plan to include a “Roth contribution program” that permits a participant to elect to have all or a portion of his or her elective deferrals treated as Roth contributions. Roth contributions are elective deferrals that the participant designates (at such time and in such manner as the IRS may prescribe) as not excludable from the participant’s gross income. The annual dollar limitation on a participant’s Roth contributions is the annual limitation on elective deferrals, reduced by the participant’s elective deferrals that the participant does not designate as Roth contributions. The plan is required to establish a separate account, and maintain separate recordkeeping, for a participant’s Roth contributions (and earnings).

A qualified distribution from a participant’s Roth contribution account is not includible in the participant’s gross income. A qualified distribution is a distribution that is made after the end of a specified nonexclusion period and that is (1) made on or after the date on which the participant attains age 59, (2) made to a beneficiary (or to the estate of the participant) on or after the death of the participant, or (3) attributable to the participant being disabled. The nonexclusion period is the 5-year taxable period beginning with the earlier of (1) the first taxable year for which the participant made a Roth contribution to any Roth contribution account established for the participant under the plan, or (2) if the participant has made a rollover contribution to the Roth contribution account that is the source of the distribution from a Roth contribution account established for the participant under another plan, the first taxable year for which the participant made a Roth contribution to the previously established account. A participant is permitted to roll over a distribution from a Roth contribution account only to another Roth contribution account or a Roth IRA of the participant.

This provision was enacted in 2001 but did not take effect until 2006, and was scheduled to expire at the end of 2010. The Pension Protection Act of 2006 makes it permanent.

EGGTRA allows employees to roll over after-tax contributions from one qualified retirement plan to another if the rollover is a direct rollover, and the plan to which the rollover is made provides for separate accounting for such contributions (and earnings). For purposes of this provision, a qualified retirement plan includes a 403(b) annuity.

After-tax contributions may also be rolled over to an IRA. If the rollover is to an IRA, the rollover need not be a direct rollover and the IRA owner has the responsibility to keep track of the amount of after-tax contributions. This provision was scheduled to expire at the end of 2010, but was made permanent by the Pension Protection Act of 2006. This provision is effective for taxable years beginning after December 31, 2006.

A tax-deferred rollover occurs when you withdraw cash or other assets from one eligible retirement plan and contribute all or part of it within 60 days to another eligible retirement plan. Prior to EGGTRA the IRS could waive the 60-day requirement in only two situations: (1) a taxpayer was performing military service in a combat zone, or (2) a taxpayer was affected by a Presidentially-declared disaster. EGGRTRA provided a third exception—the IRS can waive the 60-day requirement where failure to do so would be against ‘equity or good conscience,’ such as in the event of a casualty, disaster, or other event beyond your reasonable control. This expanded basis for qualifying for a waiver of the 60-day rollover requirement was scheduled to expire after 2010.

The enactment of the Pension Protection Act of 2006 makes the ‘equity and good conscience’ exception permanent.

The Pension Protection Act of 2006 contains a number of other changes to IRAs, including:

1. Rollovers by nonspouse beneficiaries

Under present law, a distribution from a qualified retirement plan, a 403(b) annuity, or an IRA generally is included in income for the year distributed. However, eligible rollover distributions may be rolled over tax free within 60 days to another plan, annuity, or IRA. In general, an eligible rollover distribution includes any distribution to the plan participant or IRA owner other than certain periodic distributions, minimum required distributions, and distributions made on account of hardship. Distributions to a participant from a qualified retirement plan or 403(b) annuity generally can be rolled over to any of such plans or an IRA. Similarly, distributions from an IRA to the IRA owner generally are permitted to be rolled over into a qualified retirement plan, a 403(b) annuity, or another IRA.

Similar rollovers are permitted in the case of a distribution to the surviving spouse of the plan participant or IRA owner, but not to other persons.

The Pension Protection Act of 2006 provides that benefits of a beneficiary other than a surviving spouse may be transferred directly to an IRA. The IRA is treated as an inherited IRA of the nonspouse beneficiary. As a result, distributions from the inherited IRA are subject to the distribution rules applicable to beneficiaries. The provision applies to amounts payable to a beneficiary under a qualified retirement plan or a 403(b) annuity.

The provision is effective for distributions after December 31, 2006.

2. Direct deposit of tax refunds in an IRA

Under current IRS procedures, a taxpayer may direct that his or her tax refund be deposited into a checking or savings account with a bank or other financial institution (such as a mutual fund, brokerage firm, or credit union) rather than having the refund sent to the taxpayer in the form of a check.

The Pension Protection Act of 2006 directs the IRS to develop forms under which all or a portion of a taxpayer’s refund may be deposited in an IRA of the taxpayer (or the spouse of the taxpayer in the case of a joint return). The provision does not modify the rules relating to IRAs, including the rules relating to timing and deductibility of contributions.

The form required by the provision is to be available for taxable years beginning after December 31, 2006.

3. Tax-free distributions from IRAs for charitable purposes

The Pension Protection Act of 2006 allows tax-free ‘qualified charitable distributions’ of up to $100,000 from an IRA to a church or other charity. This provision is addressed earlier in this article.

4. Tax-free distributions to persons called to active duty for at least 179 days

Under present law, a taxpayer who receives a distribution from a qualified retirement plan prior to age 59½, death, or disability generally is subject to a 10-percent early withdrawal tax on the amount includible in income, unless an exception to the tax applies. Among other exceptions, the early distribution tax does not apply to distributions made to an employee who separates from service after age 55, or to distributions that are part of a series of substantially equal periodic payments made for the life (or life expectancy) of the employee or the joint lives (or life expectancies) of the employee and his or her beneficiary. Certain amounts held in a 401(k) plan or a 403(b) annuity may not be distributed before severance from employment, age 59½, death, disability, or financial hardship of the employee.

The Pension Protection Act specifies that the 10-percent early withdrawal tax does not apply to a qualified reservist distribution. A qualified reservist distribution is a distribution (1) from an IRA or attributable to elective deferrals under a 401(k) plan, 403(b) annuity, or certain similar arrangements, (2) made to an individual who by reason of being a member of a reserve component was ordered or called to active duty for a period in excess of 179 days or for an indefinite period, and (3) that is made during the period beginning on the date of such order or call to duty and ending at the close of the active duty period. A 401(k) plan or 403(b) annuity does not violate the distribution restrictions applicable to such plans by reason of making a qualified reservist distribution.

An individual who receives a qualified reservist distribution may, at any time during the two-year period beginning on the day after the end of the active duty period, make one or more contributions to an IRA of such individual in an aggregate amount not to exceed the amount of such distribution. The dollar limitations otherwise applicable to contributions to IRAs do not apply to any contribution made pursuant to the provision. No deduction is allowed for any contribution made under the provision.

This provision applies to individuals ordered or called to active duty after September 11, 2001, and before December 31, 2007. The two-year period for making recontributions of qualified reservist distributions does not end before the date that is two years after the date of enactment.

5. Inflation indexing of income limitations on certain retirement plans

There are two general types of IRAs: traditional IRAs, to which both deductible and nondeductible contributions may be made, and Roth IRAs. The maximum annual deductible and nondeductible contributions that can be made to a traditional IRA and the maximum contribution that can be made to a Roth IRA by or on behalf of an individual varies depending on the particular circumstances, including the individual’s income. However, the contribution limits for IRAs are coordinated so that the maximum annual contribution that can be made to all of an individual’s IRAs is the lesser of a certain dollar amount ($4,000 for 2006) or the individual’s compensation. In the case of a married couple, contributions can be made up to the dollar limit for each spouse if the combined compensation of the spouses is at least equal to the contributed amount. An individual who has attained age 50 before the end of the taxable year may also make catch-up contributions to an IRA. For this purpose, the dollar limit is increased by a certain dollar amount ($1,000 for 2006).

An individual may make deductible contributions to a traditional IRA up to the IRA contribution limit if neither the individual nor the individual’s spouse is an active participant in an employer-sponsored retirement plan. If an individual (or the individual’s spouse) is an active participant in an employer-sponsored retirement plan, the deduction is phased out for taxpayers with adjusted gross income over certain levels for the taxable year.

The adjusted gross income phase-out ranges are: (1) for single taxpayers, $50,000 to $60,000; (2) for married taxpayers filing joint returns, $75,000 to $85,000 for 2006 and $80,000 to $100,000 for years after 2006; and (3) for married taxpayers filing separate returns, $0 to $10,000. If an individual is not an active participant in an employer-sponsored retirement plan, but the individual’s spouse is, the deduction is phased out for taxpayers with adjusted gross income between $150,000 and $160,000.

To the extent an individual cannot or does not make deductible contributions to an IRA or contributions to a Roth IRA, the individual may make nondeductible contributions to a traditional IRA, subject to the same limits as deductible contributions. An individual who has attained age 50 before the end of the taxable year may also make nondeductible catch-up contributions to an IRA.

Individuals with adjusted gross income below certain levels may make nondeductible contributions to a Roth IRA, subject to the overall limit on IRA contributions described above. The maximum annual contribution that can be made to a Roth IRA is phased out for taxpayers with adjusted gross income over certain levels for the taxable year. The adjusted gross income phase-out ranges are: (1) for single taxpayers, $95,000 to $110,000; (2) for married taxpayers filing joint returns, $150,000 to $160,000; and (3) for married taxpayers filing separate returns, $0 to $10,000.

Taxpayers generally may convert a traditional IRA into a Roth IRA, except for married taxpayers filing separate returns. The amount converted is includible in income as if a withdrawal had been made, except that the 10-percent early withdrawal tax does not apply.

Amounts held in a Roth IRA that are withdrawn as a qualified distribution are not includible in income, or subject to the additional 10-percent tax on early withdrawals. A qualified distribution is a distribution that (1) is made after the five-taxable year period beginning with the first taxable year for which the individual made a contribution to a Roth IRA, and (2) is made after attainment of age 59½, on account of death or disability, or is made for first-time homebuyer expenses of up to $10,000.

Distributions from a Roth IRA that are not qualified distributions are includible in income to the extent attributable to earnings. The amount includible in income is also subject to the 10-percent early withdrawal tax described above.

The Act indexes the income limits for IRA contributions beginning in 2007. The indexing applies to the income limits for deductible contributions for active participants in an employer-sponsored plan, the income limits for deductible contributions if the individual is not an active participant but the individual’s spouse is, and the income limits for Roth IRA contributions. Indexed amounts are rounded to the nearest multiple of $1,000. The provision does not affect the phase-out ranges under present law. Thus, for example, in the case of an active participant in an employer-sponsored plan, the phase-out range is $20,000 in the case of a married taxpayer filing a joint return and $10,000 in the case of an individual taxpayer.

Present law provides a temporary nonrefundable tax credit for eligible taxpayers for qualified retirement savings contributions. The maximum annual contribution eligible for the credit is $2,000. The credit rate depends on the adjusted gross income (“AGI”) of the taxpayer. Joint returns with AGI of $50,000 or less, head of household returns of $37,500 or less, and single returns of $25,000 or less are eligible for the credit. The AGI limits applicable to single taxpayers apply to married taxpayers filing separate returns.

The credit is in addition to any deduction or exclusion that would otherwise apply with respect to the contribution. The credit is available to individuals who are 18 or older, other than individuals who are full-time students or claimed as a dependent on another taxpayer’s return.

The saver’s credit was scheduled to expire after 2006. The Pension Protection Act of 2006 makes it permanent. The Act also provides that an individual may direct that the amount of any refund attributable to the saver’s credit be directly deposited by the government into an IRA, qualified retirement plan, or section 403(b) annuity. In the case of a joint return, each spouse is entitled to designate an applicable retirement plan with respect to payments attributable to such spouse. This provision does not change the rules relating to the tax treatment of contributions to such plans or other arrangements.

The Act also indexes the income limits applicable to the saver’s credit beginning in 2007. Indexed amounts are rounded to the nearest multiple of $500. The indexed income limit for single taxpayers is one-half that for married taxpayers filing a joint return.

The credit is in addition to any deduction or exclusion that would otherwise apply with respect to the contribution. The credit offsets minimum tax liability as well as regular tax liability. The credit is available to individuals who are 18 or older, other than individuals who are full-time students or claimed as a dependent on another taxpayer’s return.

The credit is available with respect to elective deferrals to a 401(k) plan, a 403(b) annuity), a SIMPLE or a simplified employee pension (“SEP”), contributions to a traditional or Roth IRA, and voluntary after-tax employee contributions to a 403(b) annuity or qualified retirement plan.

Federal law not only establishes a variety of tax favored retirement plans, but also heavily regulates those plans. Federal regulation derives primarily from the Internal Revenue Code, Department of Labor regulations, and ERISA (the Employee Retirement Income Security Act), a comprehensive law enacted by Congress in 1974 to regulate pension plans.

“Church plans” are exempt from many of the legal requirements that apply to most other retirement plans. For example, a church plan is exempt from the funding, vesting, and participation requirements of ERISA. Church plans also are exempt from the nondiscrimination rules that apply to 403(b) annuities, and they are not required to file the annual Form 5500 with the IRS.

Section 414(e) of the Internal Revenue Code defines the term church plan to include a plan “maintained for its employees by a church.” The income tax regulations clarify that for the purpose of this definition the term church includes “a religious organization if such organization (1) is an integral part of a church, and (2) is engaged in carrying out the functions of a church, whether as a civil law corporation or otherwise.”

The Pension Protection Act of 2006 has three provisions that pertain to church plans:

(1) church plans that self-annuitize

Minimum distribution rules apply to qualified retirement plans. Special rules apply in the case of payments under an annuity contract purchased with the employee’s benefit by the plan from an insurance company. If certain requirements are satisfied, these special rules apply to annuity payments from a retirement income account maintained by a church even though the payments are not made under an annuity purchased from an insurance company.

The Act provides that annuity payments provided with respect to any account maintained for a participant or beneficiary under a qualified church plan does not fail to meet the minimum distribution rules merely because the payments are not made under an annuity contract purchased from an insurance company if such payments would not fail such requirements if provided with respect to a retirement income account described in section 403(b)(9). For purposes of the provision, a qualified church plan means any money purchase plan described in section 401(a) which is a church plan that was in existence on April 17, 2002.

The provision is effective for years beginning after the date of enactment.

(2) exemption for income from leveraged real estate held by church plans

Debt-financed income of a church or other tax-exempt entity is subject to unrelated business income tax (“UBIT”). Debt-financed property is property that is subject to an “acquisition indebtedness’ and that is held to produce income. There is an exception to the UBIT rules for debt-financed property held by ‘qualifying organizations’ including retirement plans qualified under section 401(a) of the tax code.

The Act provides that a retirement income account of a church (or certain other organizations) as defined in section 403(b)(9) of the tax code is a qualified organization for purposes of the exemption from the UBIT debt-financed property rules. This provision is effective for taxable years beginning on or after the date of enactment.

(3) church plan rule for benefit limitations

Section 415 of the tax code limits the amount of benefits and contributions that may be provided under a tax-qualified plan. In the case of a defined benefit plan, the limit on annual benefits payable under the plan is the lesser of: (1) a dollar amount which is adjusted for inflation ($175,000 for 2006); and (2) 100 percent of the participant’s compensation for the highest three years. Special rules apply in some cases.

The provision provides that the 100 percent of compensation limit does not apply to a plan maintained by a church or ‘qualified church controlled organization’ (defined in section 3121(w)(3)(A) of the tax code) except with respect to “highly compensated benefits”. The term “highly compensated benefits” means any benefits accrued for an employee in any year on or after the first year in which such employee is a ‘highly compensated employee’. For 2006, a highly compensated employee is an employee who receives annual compensation of $100,000 or more. For purposes of applying the 100 percent of compensation limit to highly compensated benefits, all the benefits of the employee which would otherwise be taken into account in applying the limit shall be taken into account, i.e., the limit does not apply only to those benefits accrued on or after the first year in which the employee is a highly compensated employee.

This provision is effective for years beginning after December 31, 2006.