Taxpayers are generally allowed to deduct the fair market value of property that they contribute to a charity.
However, for a long time, the Internal Revenue Code has limited the amount deductible in certain cases (e.g., contributions of tangible personal property where the charity's use of the donated property is unrelated to its exempt purpose, and contributions to certain private foundations) to the lesser of the taxpayer's basis in the property or the property's fair market value.
The American Jobs Creation Act of 2004 provides that, for gifts of qualified intellectual property (defined below) made to charities after June 3, 2004, the initial amount deductible also will be limited to the lesser of fair market value or the donor's basis in the property. The taxpayer may be entitled to additional charitable deductions in the year of contribution or in later tax years based on a sliding-scale percentage of the "qualified donee income" that the charity receives from the contributed property.
* Amount of qualified donee income that is treated as an additional charitable contribution. If a taxpayer contributes qualified intellectual property to a charity, the charitable deduction for each taxable year of the taxpayer ending on or after the date of the contribution is increased by the applicable percentage of qualified donee income with respect to the contribution that is properly allocable to that year.
The applicable percentage is 100 percent for the year of the contribution and the next taxable year, 90 percent for the third year, 80 percent for the fourth year, and is reduced by 10 percent for each succeeding taxable year until it is only 10 percent for the eleventh year. It remains at 10 percent for the twelfth year, which is the last taxable year for which any additional charitable deduction is allowed.
The increased charitable deduction is allowed only to the extent that the aggregate of the increases with respect to the contribution exceeds the charitable deduction allowed without regard to the increases, i.e., the deduction claimed upon the contribution of the qualified intellectual property.
Example 1: On June 1, 2005, your client, an individual who is a calendar-year taxpayer, donated qualified intellectual property to a public charity. The basis of the property in your client's hand was $50,000. He may claim a charitable deduction of $50,000 for the contribution on his 2005 tax return. Assume that the charity (also a calendar-year taxpayer) will have $10,000 of qualified donee income from the property in 2005, $30,000 in 2006, $35,000 in 2007, and $40,000 in 2008. Your client will not be entitled to an additional charitable deduction from the property until the total of the applicable percentages of the qualified donee income exceeds $50,000.
In determining when your client will be able to take an additional charitable deduction, he takes into account 100 percent of the qualified donee income for 2005 and 2006, 90 percent of the qualified donee income for 2007, and 80 percent of the qualified donee income for 2008.
Thus, he takes $10,000 into account in 2005, $30,000 into account in 2006, $31,500 into account in 2007 (90 percent of $35,000), and $32,000 into account in 2008 (80 percent of $40,000).
He is not entitled to any additional charitable deduction in 2005 or 2006, since the total of the qualified donee income taken into account for those two years is only $40,000, or less than the $50,000 he deducted with respect to the initial contribution.
In 2007, your client will be entitled to an additional charitable deduction of $21,500 (the excess of the total qualified donee income taken into account for 2005, 2006 and 2007 of $71,500 over $50,000). In 2008, he will be entitled to an additional charitable contribution of $32,000, since the qualified donee income that he took into account in the three preceding taxable years was more than his deduction of $50,000 on the initial contribution. He will also be able to claim the applicable percentage of qualified donee income in each year from 2009 through 2016 as an additional charitable deduction.
* Qualified donee income defined. Qualified donee income means any net income received by or accrued to the donee that is properly allocable to the qualified intellectual property, as opposed to the activity in which the intellectual property is used.
Qualified donee income is properly allocable to a taxable year of the donor if the income is received by or accrued to the donee for the taxable year of the donee that ends within or with that taxable year of the donor. Income isn't treated as properly allocable to qualified intellectual property if it is received by or accrued to the donee after the 10-year period beginning on the date of the contribution of the property, or if it is received or accrued after the expiration of the legal life of the property.
Example 2: On May 15, 2005, your client, a calendar-year individual, contributes qualified intellectual property to a charity that has a tax year ending on Jan. 31. Your client may not take into account any income received or accrued by the charity on the qualified intellectual property after May 14, 2015.
Observation: Any income received by the charity on the property after Jan. 31, 2015, and before May 15, 2015, would be reported in its taxable year ending Jan. 31, 2016, and would be allowed as an additional charitable deduction to your client in his 2016 taxable year, which would be his twelfth taxable year ending after he made the contribution.
* Qualified intellectual property defined. Qualified intellectual property includes the following (but not if the property is contributed to certain private foundations described in Internal Revenue Code Section 170(e)(1)(B)(ii)):
* Patents;
* Copyrights other than a copyright held by the taxpayer who created it or by a transferee whose basis is determined by reference to the creator's basis;
* Trademarks;
* Trade names;
* Trade secrets;
* Know-how;
* Software other than software that is readily available for purchase by the general public, that is subject to a nonexclusive license, and that hasn't been substantially modified;
* Similar types of property to the property listed above; and,
* Applications or registrations of the property described above.
Observation: Deductions for charitable contributions of any property to private foundations described in IRC § 170(e)(1)(B)(ii) are limited to the lesser of fair market value or the contributor's basis in the property. Excluding contributions of property to those private foundations that would otherwise be treated as qualified intellectual property from the definition of qualified intellectual property means that the contributor will not be allowed any additional charitable deduction for qualified donee income received by the charity.
* Notice required to qualify for additional charitable deduction. To qualify for the additional charitable deductions, a donor must inform the donee at the time of the contribution that she intends to treat the contribution as subject to the additional charitable deduction provision. A donee that receives such a notification from the donor must file a return for each of the donee's taxable years showing the amount of any qualified donee income that taxable year, and furnish the donee with a copy of the return.
The amount of net income taken into account by the donor can't exceed the amount of qualified donee income reported by the donee. In Notice 2004-51, the Internal Revenue Service says that a donor will satisfy the notification requirement if she delivers or mails to the donee, at the time of the contribution, a written statement that contains:
* The donor's name, address and taxpayer identification number;
* A description of the qualified intellectual property in sufficient detail to identify the qualified intellectual property received by the donee;
* The date of the contribution to the donee; and,
* A statement that the donor intends to treat the contribution as a qualified intellectual property contribution.
A donor who contributed qualified intellectual property after June 3, 2004, and before June 21, 2005, without meeting this notification requirement, will be treated as satisfying the requirement if, before July 21, 2005, she delivers or mails to the donee a written statement containing the information mentioned above.
Bob Rywick is an executive editor at RIA, in New York, and an estate planning attorney.
