The new tax law enacted around the turn of the year—the American Taxpayer Relief Act of 2012 (ATRA)—extends a unique tax break for charitably inclined retirees. But the window closes again at the end of this year.
Strategy: Donate funds in your IRA to a qualified charity. Instead of taking a taxable IRA distribution and contributing the difference, tap directly into the IRA. There’s no “middle step” involved.
Although you can’t deduct the donation, you won’t pay any tax on the distribution either.
Here’s the whole story: The tax break for IRA distributions to charity officially expired after 2011, but was extended through 2013 by ATRA, retroactive to the 2012 tax year. So you still have until Dec. 31, 2013, to take action.
Under this tax law provision, an individual over age 70½ can exclude from tax “qualified charitable distributions” from an IRA of up to $100,000. The distribution isn’t reported as taxable income or treated as a charitable contribution on your return. Similarly, the payout doesn’t affect your adjusted gross income (AGI).
Key point: The distribution must otherwise qualify as a charitable donation. If the deductible amount decreases because of a benefit received in return—a dinner at a fundraising event, for example—or the deduction would not be allowed due to inadequate substantiation, the exclusion is not available for any part of the IRA distribution.
Also, contributions must be made directly from the IRA trustee to the charity. Initially, it was presumed that you couldn’t touch the money at all. But a 2007 ruling clarified that a donor can still qualify if he or she delivers a check made payable from the IRA to the charity. (IRS Notice 2007-7)
8 benefits are enough
Even without a charitable deduction, here are eight ways this strategy helps you tax-wise.
- Deductions for charitable donations may be restricted based on 30% or 50% of AGI. The IRA payout is exempt from those ceilings.
- 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.
- The charitable distribution is never realized as taxable income. This can lower your AGI for the deduction floors for medical expenses and miscellaneous expenses.
- An IRA withdrawal would normally result in taxable income that could increase tax on Social Security benefits. Using the direct IRA transfer to charity avoids the problem.
- The payout counts as “required minimum distribution” (RMD). If you take the exact amount of the RMD and transfer it to charity, you effectively convert the taxable RMD into a tax-free distribution. Then you don’t have to take another RMD until 2014.
- This tax provision might also benefit taxpayers who claim the standard deduction. It’s the equivalent of taking a tax deduction as an itemizer.
- Charitable deductions are reduced for upper-income taxpayers under the “Pease rule” (see box). This is one way to get the money to a charity without a reduction.
- The distribution avoids the calculation for the new 3.8% Medicare surtax. This is yet another consideration for upper-income taxpayers.
Can you use a Roth IRA for this purpose? Yes, but it’s generally better to use a traditional IRA. Qualified distributions are tax-free anyway, so you’re not gaining as much.
Tip: The $100,000 limit applies per taxpayer. Thus, a married couple can transfer up to $200,000 tax-free if they each have IRAs in their own name.
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