Charitable-minded retirees who have reached age 70½ have another chance to do a good tax deed with benefits. Reason: The 2010 Tax Relief Act extends a tax break for “charitable rollovers.”
Strategy: Donate funds directly from your IRA. In other words, instead of taking a taxable withdrawal and contributing the difference, you can tap into IRA funds to provide the full amount to charity. There’s zero tax due on the distribution.
This tax break for charitable rollovers officially expired after 2009. (Previously, it was set to expire after 2008, before it was extended.) Now the new tax law retroactively reinstates the provision to Jan. 1, 2010, and extends it again through 2011. So you still have a “window of opportunity” to take advantage of a charitable rollover.
How it works: An individual age 70½ 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.
Even though you aren’t entitled to a tax deduction, there are plenty of other tax “savings” available with a charitable rollover.
6 tax perks for charitable rollovers
Here’s what an eligible taxpayer can accomplish tax-wise by making this move:
1. Deductions for charitable donations may also be restricted by other rules based on 30% and 50% of AGI. The IRA payout is exempt from these ceilings.
2. If you carry over charitable deductions from the prior year, you may receive the full benefit of the deductions this year. Otherwise, the regular charitable limits are applied before the carryover is allowed.
3. The charitable distribution is never realized as taxable income. This can lower your AGI for the deduction floors for medical expenses and miscellaneous expenses.
4. An IRA withdrawal would normally result in taxable income that could increase tax on Social Security benefits. Using the charitable distribution technique avoids the problem.
5. The distribution counts toward required minimum distribution (RMD) amounts. Thus, if you take the exact amount of the RMD and transfer it to charity, you convert the taxable RMD into a tax-free charitable distribution, and you won’t have to take another RMD until 2012.
6. This tax provision might also benefit taxpayers who claim the standard deduction. It is the equivalent of taking a tax deduction as an itemizer.
Note that the tax break for charitable distributions applies to Roth IRAs as well as traditional IRAs. Roth IRA distributions to individuals who are age 59½ or older are usually tax-free. But a portion of a distribution may be taxable for a Roth in existence less than five years. Therefore, you’re usually better off using a traditional IRA rather than a Roth for this purpose.
Key requirement: The 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 fundraiser—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. Initially, it was presumed that you couldn’t touch the money at all. However, in a 2007 ruling, the IRS said a donor can still qualify if he or she delivers a check made payable from the IRA to the charity. (IRS Notice 2007-7)
Tip: The IRS also clarified that the $100,000 limit applies to each individual. Therefore, a married couple can contribute a total of up to $200,000 tax-free if they both have IRAs set up in their names.
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