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Tax Break for Wealthy IRA Owners

This week, Gail answers questions about new legislation that allows people to make donations to charity directly from an IRA.

Dear Gail-

I’m the director of a small non-profit organization that helps single moms find jobs and a decent place to live with their kids. As you can imagine, there’s never enough money to go around. Everyone here — including myself — could earn a lot more in the private sector, but this kind of job has a pay-off money can’t buy.

We just heard that the new legislation passed by Congress allows people to donate money directly from their IRAs to a charity. I understand there’s a limited window to take advantage of this. We’d like to send a letter to potential donors. What can you tell me about this?

Thank you,
Patricia

Dear Patricia,

The Pension Protection Act does, indeed, include several provisions that relate to charities.

You are also correct that for the first time an individual can directly donate assets held in an IRA to charity—as much as $100,000 per year. If done correctly, the amount will not be included in the donor’s “gross income,” which prevents a generous donor from being penalized at income tax time.

Nonetheless, this is not for to everyone. To begin with, it’s only available to IRA owners who are at least age 70-and-a-half.

Another requirement is that the money must be transferred from the IRA to the charity without ever passing through the hands of the donor. In other words, the IRA custodian has to make the check out to the charity and then actually send it.

An additional benefit is the amount transferred to a charity will count toward satisfying the “required minimum distributions”(RMDs) an IRA owner must start taking after reaching age 70-and-a-half.

For instance, let’s say William is a 78-year-old widow with an IRA worth $800,000 at the end of last year. His primary beneficiary is his niece. This year, William’s RMD is roughly $39,410.

Because William has other assets to fund his retirement, he knows he won’t need all of the money in his IRA. Furthermore, he is a dog-lover who would like to help the no-kill animal shelter in his city get a jumpstart on funding its new facility.

William could simply withdraw his RMD and donate it to the animal shelter. However, the tax experts at CCH point out that “under the present rules … donating an IRA distribution to a charity can be expensive.” That’s because although the IRA distribution is theoretically offset by the charitable deduction, “in practice the extra tax is likely to be more than the extra deduction.”

In order to deduct a charitable contribution on your income tax return, first you have to itemize. In addition, the tax code limits your annual total charitable deductions to a maximum of 50 percent of your adjusted gross income. Donations to some types of charities are limited to no more than 30 percent of your AGI. (Unused deductible amounts can be “carried forward’ and applied to future tax returns.)

Furthermore, if William’s IRA withdrawal plus his other income exceeds $75,250 this year ($150,500 if married filing jointly), his ability to deduct any charitable contributions starts to phase out.

In other words, the tax code penalizes you if you are too generous!

Under this new law — which takes effect immediately — William can bypass these complications by simply instructing his IRA custodian to send a check directly to the charity operating the animal shelter. The IRA withdrawal will not show up on his personal tax return. In essence, he can take the “standard deduction” and get the equivalent of a full deduction for his contribution. Both William and the charity benefit from this approach.

What if, in order to reduce the size of his taxable estate or because he felt especially generous, William wished to give away more than his RMD of $39, 410? In that case he could donate up to $100,000 before the end of this year and again next year. Since this would exceed the “minimum” he is required to withdraw each year, his charitable donation would satisfy his RMD requirement for 2006 and 2007. Thus, as CCH points out, “a qualified distribution does double duty: it provides for tax-free distributions and, at the same time, helps to reduce the need to make … required minimum distributions.”

However, this isn’t a strategy just for the wealthy. Mars, Pennsylvania CPA David Binder says he “can think of 40 or 50 middle class clients” this would benefit. Take a retired couple in their 70s whose income consists of a pension, Social Security, and a modest required minimum distribution. They give their church $6,000 annually, but because their total deductions aren’t high enough to impact their taxes, they don’t itemize. Thus, they end up paying income tax on their IRA withdrawal, but get no deduction for the contribution to their church.

By having the IRA send a check directly to their church, this couple avoids having to pay tax on their distribution. “It’s a way of getting a charitable contribution deduction without itemizing,” says Binder.

Not all charitable organizations qualify. For instance, private foundations, so-called
“supporting organizations” and “donor-advised” funds are not eligible for this special treatment.

And as you point out, there is a limited time period to take advantage of this strategy. The clock started ticking the day this legislation was signed (August 17th). Time runs out at the stroke of midnight on December 31, 2007.

In addition, this law contains other provisions that reflect other charity-related goals of the IRS: cracking down on dubious charities and dubious charitable contributions.

Remember the embarrassing disclosure of Bill and Hillary Clinton’s tax return that revealed they had taken a charitable deduction for donating — among other things — Mr. Clinton’s used underwear? As I recall, each set of briefs was listed as having a value of “50-cents.”

Under new rules, you’ll only get a deduction for donated clothing or household items if they are in “good condition.” The law instructs the IRS to come up with a definition. (I’m sure the Clintons are breathing a sigh of relief that this won’t apply retroactively.)

Provided your organization would qualify to receive direct IRA-to-charity donations, this law could help it gain sounder financial footing. But you won’t be the only charity clamoring for the attention of wealthy donors, so the sooner you get the word out, the more donations you’re likely to capture.

Thanks for your good works,
Gail

If you have a question for Gail Buckner and the Your $ Matters column, send them to: yourmoneymatters@gmail.com, along with your name and phone number.