DECEMBER 22, 2010 8:59 PM
North Dakotans can take advantage of state income tax credits that few others in the United States can. Since 2005, state residents have been able to participate in income tax credits for planned gifts. In 2007 the state’s business donors were given the opportunity to qualify for tax credits based upon gifts to qualified endowment funds. Both opportunities are believed to exist in only a handful of other states including Montana, Iowa, and Kentucky, and are the result of legislation intending to promote greater giving to North Dakota’s nonprofit entities. (See, ND Century Code 57-38-01.21)
Tax Credits for Planned Gifts
A planned giving tax credit, originally enacted in 2005 and enhanced in 2007, allows individual tax filers to claim up to a $10,000 credit and joint tax filers up to a $20,000 credit for planned gifts made to qualifying North Dakota nonprofit organizations. The amount of the credit is computed at 40% of the federal deduction created by the gift. The credit may be claimed in the year of the gift, plus a carry-forward period of three years. Eligible planned gifts include: various types of charitable trusts, current and deferred charitable gift annuities, certain paid-up life insurance policies, pooled income fund trusts, and charitable life estate agreements.
Endowment Credit Aimed at North Dakota “Business Entities,” Estates and Trusts
In an effort to encourage greater giving to endowment funds held by North Dakota nonprofits, in 2007 the state legislature enacted a new credit for business gifts to qualifying endowment funds. The law allows eligible entities to qualify for a 40% state income tax credit up to $10,000 annually. Thus, eligible gifts up to $25,000 will bring about the maximum credit. Eligible entities under the law include C corporations and pass-through entities such as S corporations, partnerships, and limited liability companies (LLCs). Trusts and estates filing an income tax return are also eligible. Currently, banks are not eligible for this credit since they are taxed under a separate section of the North Dakota Century Code.
Multiple Gift Opportunity
The $10,000 annual maximum tax credit for endowment gifts is determined at the entity level, therefore an individual owning an interest in multiple “pass-through” entities may exceed the $10,000 limit on their individual return. For example, an owner of four eligible entities may make four separate $25,000 endowment gifts (one from each entity) for total gifts of $100,000, deriving a total North Dakota income tax credit of $40,000 which is available in the year of the gift plus three (3) carry forward years. As can be seen in this example, the law allows for some very significant gift and tax planning considerations.
Readying Nonprofits to Accept Qualifying Endowment Gifts
Though many nonprofit organizations operate quite well without the presence of an endowment fund, the formation of a “qualifying” endowment by definition under the North Dakota tax credit for endowments may give an organization’s supporters access to the tax incentives that may ultimately encourage them towards greater and more frequent giving. Craig Johnson, CFRE; CPA of Fargo, was directly involved in drafting and promoting both the planned-giving tax credit legislation in 2005 and the endowment credit bill in 2007. He and Fargo attorney Richard Anderson have prepared model documents to assist their clients in establishing a qualifying endowment. Johnson advises nonprofits to work with professional counsel so that the fund’s governing documents allow it to qualify as a “permanent, irrevocable fund” as required by this law. Anderson further stresses the importance of defining the fund as a true endowment, adding, “be certain that your fund is a ‘true endowment’ rather than a ‘quasi-endowment’ fund. Clarifying the true nature of your fund will avoid instances of disqualified contributions. It protects your donor’s interests which is critical in any donor/beneficiary relationship.” A true endowment is one that allows only the endowment’s earnings to be spent and does not allow for invasion of principal; except in extreme situations.
Enhancements Proposed for Endowment Credit
There is a movement underway to amend the endowment credit law to expand participation to include financial institutions and individuals. The issue will be taken up during the 2011 legislative session. Financial institutions— which are not eligible under the current law though historically have been incredibly socially conscious and philanthropic leaders of their respective communities— are taxed under a separate provision of the N.D. Century Code and were therefore originally excluded. Changes being proposed for legislative consideration would extend to financial institutions the same provisions as other eligible business entities, though it would be addressed specifically in the Code pertaining to bank taxation. Provisions that would allow individuals to partake of the endowment tax credit are still being finalized, however would most likely include a minimum annual aggregate contribution to claim the credit. For instance, an individual who contributes a minimum of $5,000 to one nonprofit’s qualifying endowment fund would be eligible for the 40% ($2,000) credit. The gifts could be made in increments, ($1,000 x 5) as long as the aggregate equals or exceeds $5,000. The annual maximum credit for individual tax filers would likely be $10,000, making the optimal aggregate gift $25,000 which is the same for the business entity credit.
Experts Weigh In
Johnson is not discouraged by the statistics reflecting a slow, steady upswing in use of the credits, but believes it will take time until these opportunities become part of the culture of North Dakota giving. “I believe steps are being taken to promote the benefits of the income tax credits through articles and seminars,” states Johnson. “the more nonprofits are prepared to accept gifts qualifying for the planned gift and endowment credit, the more their donors will benefit.”
Dana Schaar, Executive Director of the North Dakota Association of Nonprofit Organizations (NDANO) echoes Johnson’s sentiments saying, “Expanded educational efforts to increase knowledge of the endowment credit are vital, particularly for nonprofits and financial planners. NDANO is committed to helping nonprofits learn more about these tax credits and how they can use the incentives to increase planned and endowment gifts to provide long-term support for their work.” Both agree that the discussion must begin through informed nonprofits and advise nonprofit executives to routinely meet with their donors and the professional advisor community about the benefits of any new or existing charitable tax laws.
Gordon Binek of Bismarck State College Foundation believes the enhancements to the endowment credit law will help attract more use. “It will create a greater awareness of endowment funds operated by charities. North Dakotans are very practical people when we have the opportunity to reduce our cost of a gift to a favorite charity we’re going to take advantage of the benefit,” declares Binek, who is supportive of the effort to include individual donors in the endowment credit. Allowing individual donors to participate has concerned some nonprofits who believe it will force their donors to make a choice between a gift to the annual fund for immediate needs, and a gift to the endowment where the greatest tax benefit lies. They have suggested higher minimum contributions to qualify for the credit so as to not affect annual gifts. Binek weighs in on the concern advising, “Some [donors] may alternate their annual support of charities to take advantage of the credit. Charities will need to recognize that they may not receive another gift from that donor for two or three years. Eventually, the endowment fund will grow enough to generate annual distributions which help support the charity.”
More discussion on the enhancements will likely ensue as the bill winds its way through the legislative process. The issues surrounding the unique taxation of financial institutions will undoubtedly be discussed, as will the aggregate minimum contribution from individuals. Regardless of the specifics in the final draft, North Dakota will continue to be a national leader in creating incentives for charitable giving. The state’s donors, nonprofits, and those benefitting from their generosity and mission can be grateful for the insight shown by our legislators.
To track the progress of the bill, visit the North Dakota Legislature website: www.legis.nd.gov or the NDANO website: www.ndano.org.