Rule changes at the IRS could affect your strategy for cash gifts and charitable donations.
Just in time for Christmas (and here when most of us do our tax planning), the Internal Revenue Service has come up with a slew of rule changes that should make it easier to make gifts not only to favorite charities, but to loved ones as well.
First off, the annual gift-tax exclusion (which doesn’t count against the $1 million lifetime limit) has been increased to $12,000 for 2006—up from $11,000 last year. That’s the amount you can give to any beneficiary in a single year without triggering gift taxes.
“The exclusion is indexed to inflation,” said Gary Hoff, ag taxation specialist, University of Illinois. “In succeeding years, the exclusion will go up to keep pace with inflation, but only in $1,000 increments. Therefore, it may increase in some years but not in others.”
Here’s how that would work: Say you and your spouse have two children or grandchildren. You can give each child up to $12,000 this year and your spouse can give each child $12,000, for a total of $48,000. Further suppose that one child is a full-time college student and that the other has serious health problems. You can make gifts to pay for education and medical care, with virtually no limit on the amount.
“The only requirement is that the payments need to be made to the institution [college, or doctor or hospital], rather than to the individual,” said Parman Green, University of Missouri farm management specialist.
Your tax situation may benefit from giving gifts of commodities (bushels of grain or head of livestock) rather than cash. You’ll want to talk with your tax preparer about this.
“Whether you give to charity or to an individual, give grain from a prior year’s production, especially if you are on a cash accounting basis,” said Green. “You’ve already deducted production expenses on that grain, whereas you have not yet deducted expenses for this year’s crop.”
But it depends on how the non-cash gift is made as well as when.
“If I give the church 1,000 bushels of soybeans and simply tell the elevator to sell the beans and give the church the check, that’s an assignment of income and is taxable,” noted Green.
However, there are two features in this kind of donation that should be considered. First, as already mentioned, are the deductible expenses that went into producing the grain—another reason for keeping good cost-of-production records. Secondly, since you are not selling the commodity, you are reducing your income, which lowers your tax liability. And don’t overlook the reduction in self-employment tax for Social Security and Medicare, which reduces your tax liability still further. If you are in a 25-percent income tax bracket and do not pay the 15-percent self-employment tax on those given-away bushels, you’re saving 40 percent.
For landlords in a share-crop situation, things are a bit more complicated.
“Commodity contributions by a landlord usually are considered as transferring the rent the landlord would have received to the charity involved and are treated as cash gifts and need to be reported the same way,” said Hoff. “But whether a landlord can deduct a charitable commodity contribution may depend on how much participation the landlord has in the operation and when the rental payment is received, not when the grain might be sold.”
For landlords, “in-kind” gifts such as grain or animals are valued as of the time the commodity changes hands in most instances, Hoff added.
By the same token, non-cash wages are reported at the fair market value of the commodity at the time it changes hands. Employers are required to complete a W-2 form that includes the value of the commodity and are also required to withhold income tax. However, in-kind wages are exempt from FICA and Medicare withholding.
In some cases—and in some states—there may be tax advantages to paying part or all of the cost of business equipment with commodities. However, many states (Missouri, for one) exempt machinery bought for business purposes from sales taxes.
“There aren’t many advantages to using commodities to pay part or all of the cost of a tractor or combine, and very few farmers do that,” said Ron Andresen, sales manager for Sydenstricker Implement Company in Palmyra, Mo. “But in-kind payments may save sales taxes on non-business purchases, such as a lawnmower or automobile for personal use.”
“But you need to own the commodity going into the transaction,” said Green. “For example, you aren’t allowed to go out and buy grain just to trade it and save sales taxes.”
And you’re still liable for income taxes on the commodity swapped.
“In most cases, the IRS would view this as a barter transaction, and barter income is taxable,” said Hoff.
Other rule changes on gifts and savings make giving less onerous. For instance, current rules make it difficult for workers to bequeath 401(k) assets to anyone other than a spouse without triggering a tax hit. Beginning next year, non-spouse beneficiaries can roll over bequeathed 401(k)s into an “inherited” IRA (individual retirement account) and can withdraw the money gradually.
“There are changes in IRAs, too,” said Hoff. “Under the old rules, investors who withdrew IRA funds for charitable giving had to pay taxes on the money withdrawn. Now, IRA owners who are 70-1/2 or older can withdraw up to $100,000 per year tax free to give to qualified charities.”
