Why you should think about donating IRA funds to charity

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in Small Business Tax,Small Business Tax Deduction Strategies

Time is running out on a unique tax break for older taxpayers with charitable intentions.

Strategy: Donate funds directly from your IRA. Instead of taking a taxable withdrawal and contributing what’s left after taxes, give the full amount to charity.

There’s no tax due on the distribution.

The 2006 pension law created a two-year window for tax-free distributions of up to $100,000 by certain taxpayers. This provision was extended through 2009 by last year’s bailout law.

Here’s the whole story: If you are age 70½ or older, you can exclude from tax “qualified charitable distributions” of up to $100,000 that would otherwise be taxable as IRA distributions. A qualified charitable distribution isn’t reported as taxable income or claimed as a charitable deduction. Similarly, the distribution won’t increase your adjusted gross income (AGI) for other tax purposes.

Just look at what you can accomplish by making this move:

  • Normally, itemized deductions are reduced for high-income taxpayers, but this charitable gift isn’t affected by the itemized deduction reduction.
  • Deductions for charitable donations also may be restricted by other rules based on 30% and 50% of your AGI. The IRA payout is exempt from these ceilings.
  • If you’re carrying over charitable deductions from the prior year, you may receive the full benefit of the carryover this year. Otherwise, your regular charitable deductions are applied before the carryover is allowed.
  • The charitable distribution is never realized as taxable income.
  • An IRA withdrawal normally would result in taxable income that could increase tax on Social Security benefits. The charitable distribution technique avoids the problem.

This tax provision might also benefit elderly relatives who claim the standard deduction. It’s the equivalent of a tax deduction as an itemizer.

Note that the tax break for charitable distributions applies to Roth IRAs as well as traditional IRAs.

Key requirement: Your contribution must otherwise qualify as a charitable donation. If the deductible amount is reduced because of a benefit received in return (say, the value of a dinner at a fundraising event) or the deduction would not be allowed due to inadequate substantiation, the exclusion isn’t available for any part of the IRA distribution.

Also, contributions must be made directly by an IRA trustee to the charitable organization. But the IRS said you still can qualify if you deliver a check made payable from your IRA to the charity. (IRS Notice 2007-7)

Tip: The IRS also clarified that the $100,000 limit applies to each taxpayer. So a married couple can contribute a total of $200,000 tax-free.

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