Tax Law and Business Organization Strategy

Charitable Giving From IRA's *

Please Note:  This article is only relevant for charitable giving from your IRA through the end of 2007.

In August 2006, Congress passed the Pension Protection Act of 2006 (the “Act”), a massive tax bill that contains liberalized retirement account payout and rollover rules.  Following is a summary of one of the key tax changes in this important new legislation—charitable giving.

The Act contains provisions to provide additional tax incentives for Americans to give more resources to the charitable community.  One incentive allows taxpayers to exclude from gross income (“GI”) certain distributions of up to $100,000 from a traditional or Roth IRA if made to a tax-exempt organization to which deductible contributions can be made.

Under pre-Act law, if an amount withdrawn from a traditional or Roth IRA was donated to a charitable organization, the rules relating to the tax treatment of withdrawals from IRAs applied to the amount withdrawn, and the charitable contribution was subject to the normally applicable limitations on deducting charitable contributions.

However, under the Act, for distributions in tax years beginning in 2006 and through the end of 2007, the Act provides an exclusion from GI, up to $100,000, for otherwise taxable IRA distributions from a traditional or Roth IRA that are qualified charitable distributions.  Additionally, the amount of the qualified charitable distribution counts towards the taxpayer’s required minimum distribution (“RMD”) for the year. To constitute as a qualified charitable distribution, the distribution must be made: (1) directly by the IRA trustee to a qualified public charitable organization; and (2) on or after the date the IRA owner attains age 70 and 1/2. 

A qualified charitable distribution is excludible from GI only to the extent that the distribution would otherwise be includible in GI, is counted toward the taxpayer’s RMD requirement for the year, and is not taken into account in determining the individual's charitable contribution deduction for the year. In other words, the qualified charitable distribution is a free gift to charity with no negative income tax consequences to the donor.

The new provision clearly saves taxes for those taxpayers who do not itemize, but can also save taxes for taxpayers who itemize to the extent charitable limitations would have reduced the amount deducted.  Even if limitations would not cause a reduction in the amount of the charitable deduction, the new provision can still save taxes by lowering adjusted gross income (“AGI”) and thereby making it less likely to lose certain tax breaks pegged to AGI, such as medical expense deductions.  Finally, using IRA distributions, rather than other funds, to make charitable contributions can help to reduce the amount of social security benefits included in gross income.

Cautions:  (1) The exclusion does not apply to distributions from all types of IRAs (it does not apply to distributions from SEPs). (2) The exclusion applies only to contributions to qualified public charities. (3) A qualified charitable distribution must be made directly by the IRA trustee to a charitable organization.  Thus, a distribution made to an individual, and then rolled over to a charitable organization, would not be excludible from GI.  (4) If the IRA owner has an IRA with nondeductible contributions, a special rule applies in determining the portion of a distribution that is includible in GI and thus is eligible for qualified charitable distribution treatment. (5) Not all plans will allow this charitable distribution. So before planning any charitable gifts from your IRA, ask your Plan Administrator and your financial advisor to determine whether your plan will allow a gift to a charity and whether your distribution will qualify as a qualified charitable distribution.

* Taken in part from RIA's "Complete Analysis of the Pension Protection Act of 2006"

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