Strategy: Contribute to charity directly from your IRA. Under the new law, qualified charitable distributions up to an annual $100,000 cap are exempt from tax. This tax break, dubbed the “charitable IRA rollover” is available only for the 2006 and 2007 tax years.
Best of all, the contribution can reduce or completely wipe out the tax on required minimum distributions (RMDs) from an IRA.
The whole story: Before the Pension Protection Act of 2006, affluent taxpayers were penalized if they used IRA funds to donate to charity. Reason: You’re generally required to pay tax on the IRA distributions you receive. But most tax deductions claimed on Schedule A— including deductions for charitable contributions — were partially phased out at higher income levels. So, you lost to Uncle Sam in the trade-off.
The tax law also worked against retirees who wanted to use IRA funds to donate to charity but no longer itemized their deductions.
New tax opportunity: The new law provides a two-year window for those age 701/2 and older. If you direct the IRA funds to charity, you don’t have to pay any tax on distributions up to the $100,000 limit. (Of course, you get no deduction, either.) You can take advantage of this provision this year and next.
For this purpose, a “qualified charitable distribution” means a distribution from either a traditional or Roth IRA that would otherwise be taxable.
To qualify for the exemption, you must make the distribution directly from the IRA trustee to a qualified charitable organization. So, you can’t take an IRA distribution and then roll it over or transfer it to the charity’s coffers. In fact, your hands should never touch the money.
Furthermore, the contribution must otherwise qualify as a charitable donation. If the deductible amount decreases because of a benefit received in return — for a dinner at a fund-raising 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.
Under a special rule for charitable donations, the IRS will treat distributions from an IRA funded at least partially with nondeductible contributions as coming first from taxable funds and then from nontaxable funds. All of your IRAs are grouped together for the calculation.
Finally, you’re generally required to begin receiving distributions from an IRA in the year after the year that you turn 701/2. The new law counts qualified charitable distributions as RMDs. In effect, if you direct your required distribution to a charity this year, you’ll pay no tax on it.
Note: This also applies to Roth IRAs. Roth IRA distributions to individuals over age 591/2 are usually tax-free. But a portion of a distribution may be taxable for a Roth in existence less than five years.
Tip: If you have both a traditional IRA and a Roth, use the traditional IRA first for charitable distributions.
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