This week Gail walks through the creative ways generous Thanksgiving givers can help out Americans in trouble.
While we should do it year round, November is "officially" the month we count our blessings and give thanks. Often that takes the form of helping those less fortunate. As this column illustrates, there are creative ways to do this, regardless of the size of your gift.
I'm thankful people like you read this column. Hope it helps. Let me know how it could be better.
We've heard there's a way for people to contribute to the hurricane relief efforts through their employers. What can you tell us about this?
Tom, Marsha, & Jordan
I assume you're referring to the "Leave Donation" program. Here's how it works: instead of cash, an employee donates sick leave or vacation time back to his/her company. The company converts that into a dollar amount and makes a contribution to charity.
The Leave Donation program was last used to assist relief efforts following the 9/11 disasters. It was reinstated in September in the wake of Hurricane Katrina. As a result, only charities specifically providing aid to victims of Katrina qualify. (Sorry Galveston and Ft. Lauderdale. "Rita" and "Wilma" don't count.)
The benefit to the employee is that your income is reduced by the value of the donation, which means you don't have to pay income or FICA tax on this amount. The amount reported on your annual W-2 will reflect this adjustment. However, since you're not getting taxed on this income, you don't get a deduction for it.
It's important to recognize that this approach puts more money into the hands of a designated charity than it would get if you received it as income and had to pay taxes on it.
The tax deduction goes to the employer, who has a choice of taking it as either a business expense or charitable deduction.
According to IRS Commissioner Mark Everson, "Everybody wins under this program. Employees can give without paying cash. Companies get the tax deduction. And the money gets to people in need."
Groups as diverse as the American Trucking Association and Independent Community Bankers of America are supporting this effort. If your employer doesn't have a Leave-Donation plan in place, it can be set up relatively easily according to Mike O'Toole, Senior Director of Publications and Government Relations at the American Payroll Association. While the IRS has issued the basic rules that have to be followed, "There is no plan that has to be formally set up," says O'Toole.
In addition, no reports have to be filed. According to an IRS spokesperson, the only requirements are that the leave donation program is clearly explained to employees and that there is documentation supporting the company's deduction. Refer your human resources department to IRS Notice 2005-68 which can be found at www.irs.gov. Typing "leave donation" in the site's search engine will lead you to a very good "FAQs" page.
The Hurricane Katrina Leave Donation program lasts through Dec. 31, 2006. It's a way for people who don't have extra cash to make a donation.
If you've got the means and the motives to be especially generous, read on ….
I'm one of those lucky "dot.com'ers"- I cashed in the stock I had in my 401(k) before the market collapsed and when I left my company I rolled about $5 million into an IRA. Since I've got more money than I'll ever need, I'd like to put it to good use, especially in light of the natural disasters we've had in recent years.
I understand the tax code has been changed to allow bigger deductions for charitable donations. If I made a donation equal to my income this year, could I zero out my income and wipe out my tax bill? It seems to me this would be a way to get some money out of my IRA without paying tax on it. I'd rather see it go to a charity than the government.
Congratulations! You belong to an elite group. According to the most recent IRS figures, in 2002 only 428,835 taxpayers were wealthy enough — and charitable enough — to give away more than half their annual income in a single year.
You're correct that the Tax Code limits the annual deduction you can take for making gifts to a charity. If you donate cash, the maximum deduction is 50 percent of your adjusted gross income (AGI) for that year. (Different limits to the deductibility of other types of property.)
Suppose your AGI is $200,000 and you write a $150,000 check to a public charity (see Section 170(b)(1)(A) of the Internal Revenue Code). Your maximum 2005 deduction would normally be $100,000 (50 percent x $200,000). The remaining $50,000 could be "carried forward" for up to five years and deducted against future income.
However, the Katrina Emergency Tax Relief Act of 2005 (fondly known as "KETRA") lifts this limit. But only for contributions made from Aug. 28 through Dec. 31 of this year. During this window, individuals can deduct 100 percent of any cash gifts they make to a qualified charity, regardless of the amount.
Donations made prior to Aug. 28 would still be subject to the 50 percent cap.
Christopher Hoyt, a law professor at the University of Missouri in Kansas City, explains it this way:
Assume your annual income is $100,000. In the first half of this year you donate $60,000 to your alma mater to help pay for a new wing in the library. Then, in the wake of hurricanes Katrina, Rita, and Wilma you write a check to the American Red Cross for $20,000. For 2005, your cash donations total $80,000, but you are only allowed to deduct $70,000 on this year's income tax return.
Here's why: The 50 percent cap still applies to the donations you made priot to August 28th. Since your annual income this year is $100,000, this limits your deduction on the money given to your former college to $50,000 (50 percent x $100,000). However, your $20,000 contribution to the American Red Cross, which was made in October, is 100 percent deductible. $50,000 + $20,000 = $70,000. The remaining $10,000 is carried forward into 2006.
Although this exception to the 50 percent limitation is included in the "Katrina" tax relief act, there is no requirement that you donate to a charity assisting hurricane victims. The only requirements are that your gift be:
1. In cash (checks and credit card donations are equivalent to cash);
2. To a "qualified" public charity (this does not include "support" organizations such as "Alumni for a New Football Stadium," most private foundations, or so-called "donor-advised" funds);
3. Made from August 28, 2005 through December 31st, 2005.
Should You Use IRA Money?
You add a new dimension — and extra complexity — if you take money from your IRA to make your charitable contribution. In addition, even if your IRA withdrawal and your donation were the same amount, you would probably still owe some federal tax. According to Hoyt, that's because the amount withdrawn from your IRA gets added to your other income for the year. Once this exceeds $145,950 (2005), your itemized deductions (state and local taxes, mortgage interest, etc.) as well as your personal exemptions start to phase out.
Let's say your income is over $145,950. "If you take $100 from your IRA and endorse the check to a charity, you have $100 of additional income and a $100 charitable deduction," says Hoyt. "But for every $100 in additional income, you lose about $3 worth of itemized deductions." This effectively reduces your charitable deduction to about $97.
Thus, if you're in the one of the top tax brackets, for every $100 increase in your income due to your IRA withdrawal, you would owe about one additional dollar in federal income tax. This works out to a tax rate of 1-2 percent per $100. Not a big deal. But not exactly "zero," either.
Suppose you are a couple who has $200,000 in non-IRA income this year. We'll assume you have $23,600 in non-charitable, itemized deductions. Your personal exemption is $6,400. The first column shows what your federal tax would be if you took no money out of your IRAs. The next four columns illustrate the impact of taking an IRA withdrawal, donating the full amount to charity, and getting an income tax deduction for this.
|Impact of IRA Withdrawal on Income Tax Deduction|
|IRA Withdrawal/ Charitable Gift Amount||$0||$10,000||$100,000||$500,000||$1,000,000|
|Adjusted Gross Income||$200,000||$210,000||$300,000||$700,000||$1,200,000|
|Phaseout of Itemized Deductions||-$1,622||-$1,922||-$4,622||-$16,622||-$18,880|
|Income Tax Owed||$37,786||$37,870||$39,787||$44,289||$45,034|
|Additional Tax due to IRA Withdrawal/Gift||N/A||$84||$2,002||$6,503||$7,248|
|Source: Professor Christopher Hoyt, U. of Missouri (Kansas City) School of Law|
Check Your State Law!
Before you even think about doing this, be certain you understand how your state treats charitable contributions! Surprisingly, in a number of places there is no deduction allowed for this on your state income tax return.
Say your income is $200,000 and you take a million bucks out of your IRA and give it to your favorite charity. On your federal return you get a $1 million deduction. As indicated in the above chart, this would have a relatively minor impact on your federal tax bill.
"But in at least six states that don't allow charitable deductions, you would have to pay state income tax on $1.2 million," says Hoyt. Those states are: Indiana, Massachusetts, Ohio, Connecticut, Michigan, New Jersey. California limits charitable deductions to 50 percent of your income.
According to Hoyt, Illinois and Pennsylvania also don't have any deduction for charitable gifts. But since these states don't tax retirement income, your IRA withdrawal would not be taxable, anyway.
The point is, before you give, it makes sense to receive — advice. Check with a competent tax professional about the consequences of using this approach in your state.
How Old Are You?
There is no relief from the "early withdrawal" penalty on IRAs. If you are under aged 59½, you would get hit with a 10 percent tax on the amount of your withdrawal, regardless whether you use it to buy a boat or give it to charity.
Obviously, this significantly reduces the size of your withdrawal. On a $100,000 dollar IRA withdrawal the penalty amounts to $10,000. On a $1 million withdrawal, it's $100,000! This is money that is going straight to the U.S. Treasury instead of a charity — or you.
This makes no sense at all. If you're not at least age 59½, find another account from which to make your contribution.
If you have a question for Gail Buckner and the Your $ Matters column, send them to firstname.lastname@example.org, along with your name and phone number.