Charitable Donations Get Stricter Tax Rules

Soon you'll need a receipt or canceled check for every gift. And those old jeans must be in 'good' shape.

August 27, 2006

The nation's new pension law may have an unexpected effect on your ability to deduct charitable contributions.

The Pension Protection Act of 2006, passed this month, was aimed at shoring up the beleaguered defined-benefit pension system. But it includes a variety of unrelated provisions, including some that govern the type of proof that will now be required to claim tax breaks for gifts to charities, including cash and clothing given to organizations such as Goodwill and the Salvation Army.

The bottom line: Where the government once was willing to trust that you weren't padding the deducted value of small gifts, now you're going to need proof that you gave something — and something of real value — if you want to deduct it.

"I don't know if the Salvation Army kettle people are going to start giving receipts, but that's essentially what would be required if you wanted to claim the dollar you contributed as a deduction," said Mark Luscombe, principal tax analyst with CCH Inc., a Riverwoods, Ill.-based publisher of tax information.

Under current law, taxpayers are largely taken at their word when claiming $20 placed in the church collection plate, or the relatively minor amounts of out-of-pocket cash that they might throw into the Salvation Army's annual Christmas kettles.

Documentation has been required only for a donation of $250 or more. But, if audited, taxpayers are expected to supply a written record of how much they gave and to whom.

The new law, however, requires that taxpayers have a receipt or canceled check for every monetary donation. A taxpayer's written record is no longer enough.

"This is going to have a really big impact," said John Hewitt, founder of Liberty Tax Service in Virginia Beach, Va. "I know I give hundreds of dollars in small cash donations every year. Now, you won't be able to do that without getting a receipt."

Receipts or canceled checks do not have to be provided with a tax return, but can be demanded if the taxpayer is audited. If the taxpayer doesn't have the desired proof, deductions can be disallowed.

The bright side: For calendar-year taxpayers — that's most of us — the provision doesn't take effect until next year.

Rules on donations of old clothing and household items also were tightened up by the law, Luscombe said.

Deductions now can be taken only if the donated items are in "good" condition or better. Exactly what that means is a mystery; the law does not define good condition.

Computer programs that help taxpayers value deductions will still be allowed, he added. But they may need to be revised, said Bob Meighan, vice president of Intuit Inc.'s Turbo Tax software division. That's because their programs have allowed for gifts of "excellent," "good" or "fair" quality.

Under the new rules for noncash donations, which went into effect when the law was signed Aug. 17, a donated item can be deducted in "fair" condition only if it's worth $500 or more, and the taxpayer gets an appraisal to prove it.

Hewitt speculates that some charities will add a box to their receipts for noncash contributions to note their condition. Until that happens, it's up to the taxpayer to establish their value, so those who give away a lot of clothing and housewares may want to include more detail in their records, Luscombe added.

"In the past, it probably would be fine if you just said you'd given 10 dresses and five pairs of slacks," Luscombe said. "Maybe now you have to say a little more — and possibly get the charity to sign off on your assessment of condition."

Luscombe speculates that legislators made these changes because they thought the tax system was suffering "a death of a thousand cuts." Americans donate $9 billion a year in clothing and used household items.

"I think there was a concern that maybe everybody was fudging by just a few bucks," he said. "If that happens millions of times, the dollars really start to add up."

(Rules governing donations of automobiles, another area in which legislators believed there was widespread cheating, were tightened under a 2004 tax law. Now, if a charity sells — rather than uses — a donated car, the donor can write off only the amount the charity received for the car.)

Other changes in the recently enacted law:

• One provision makes it easier for wealthy seniors to donate money from their retirement plans by allowing gifts of as much as $100,000 to be directly distributed to the charity, instead of distributed to the donor, who would then give the proceeds.

How does that help? Before, such a distribution boosted the taxpayer's taxable income, possibly causing a shift into a higher tax bracket and making otherwise untaxed Social Security benefits subject to tax.

The change makes it more likely that wealthy seniors will give gifts while they're living, rather than donate them from their estates, said Marcus Lingenfelter, vice president for advancement at Harrisburg University of Science and Technology.

• Wealthy hunters, who had written off the cost of exotic hunts by giving their kill — stuffed and mounted — to nonprofit organizations, will face new restrictions on what they can deduct.

Under the new rules, only the cost of the taxidermy would be deductible — not the cost of the trip, gun or bullets. And if the charity doesn't use the gift in the course of its operations, the deduction could be disallowed.

• Taxpayers who gave property to conservation groups also will be restricted. Two years ago, IRS Commissioner Mark Everson told Congress that gifts of "conservation easements" were rife with abuse, with taxpayers overvaluing the gifts and charities doing little to monitor the property. New rules ensure that donors don't maintain control over property that has been deducted as a charitable gift.

Kathy M. Kristof welcomes your comments. Write to Personal Finance, Business Section, Los Angeles Times, 202 W. 1st St., Los Angeles, CA 90012, or e-mail kathy.kristof@latimes.com. For previous columns, visit latimes.com/kristof.