New Tax Provision Favors Giving IRA Benefits to Charity
Among the provisions that President Bush signed into law as part of the Pension Protection Act (PPA) in 2006 is a provision that for the first time will allow taxpayers to make direct contributions from an Individual Retirement Account (IRA) to a public charity such as a church or college. Under the PPA, a direct contribution from an IRA to charity is called a qualified charitable distribution. No longer will eligible taxpayers have to first withdraw the funds from an IRA, report those funds as taxable income, and then make a gift that qualifies for a charitable deduction. To the extent this provision applies, the taxpayer has no taxable income or corresponding charitable deduction for the qualified charitable distribution.
There are several disadvantages to taking funds out of an IRA and then giving those funds to charity. First, taxpayers who itemize may not get a full deduction for the charitable contribution because there is a reduction in itemized deductions for high income taxpayers (over $156,400 in 2007 and $159,950 in 2008). Second, this approach increases a taxpayer’s adjusted gross income, which may have effect on several other tax provisions, such as: (a) the percentage income limitations on charitable contributions, (b) the deductibility of medical expenses and miscellaneous itemized deductions, and (c) the taxation of Social Security benefits. In addition, this approach could expose a taxpayer to the alternative minimum tax. Finally, a taxpayer who does not itemize deductions will not realize any income tax benefit from the charitable contribution.
New Law and Its Advantages
Eligible taxpayers can now avoid the disadvantages described above when using the new provision under the PPA. However, this provision has many limitations and rules requiring strict compliance. This provision may be used only by individuals age 70-1/2 or older when the distribution is made, is limited to distributions of $100,000 per year, and is available only in 2006 and 2007. An IRA beneficiary who is over age 70-1/2 can make a qualified charitable distribution from an inherited IRA. Married individuals can each contribute $100,000 from their own IRAs. The law has not yet been extended beyond 2007. Hopefully, this new tax law will be extended beyond 2007, but so far Congress has not acted.
A very favorable aspect of the new provision is that funds directed from an IRA to a public charity will be counted in satisfaction of the annual required minimum distribution from an IRA for a person who has attained 70-1/2. Many taxpayers who do not need the annual required minimum distribution for support, and who do not want additional taxable income, have found this aspect of the provision to be very significant.
Unfortunately, this provision is limited to contributions from IRAs (other than ongoing SEPs and SIMPLEs). Charitable contributions from qualified retirement plans and 403(b) plans will not receive this favorable treatment. An ongoing SEP or SIMPLE IRA is one to which an employer contribution is made for the plan year ending with or within the IRA owner’s taxable year in which the charitable contribution would be made. Distributions from a Roth IRA qualify, but only if the distribution is included in the IRA owner’s gross income, which is generally not the case. The qualified charitable distribution is deemed to come first from the IRA owner’s pretax IRA funds if there are nondeductible contributions in the IRA.
Another restriction is that qualified charitable distributions must be made to public charities other than donor-advised funds and supporting organizations. A qualified charitable distribution cannot be made to a charitable remainder trust, pooled income fund or a charitable gift annuity.
At the direction of the IRA owner, the charitable contribution may be made by the IRA Trustee directly to the charity. In the alternative, the IRA Trustee may provide a check payable to the charity to the IRA owner that he or she can personally deliver to the charity. A qualified charitable distribution is not subject to withholding. Before making the gift, a taxpayer should consult with his or her tax advisor, the financial institution holding the IRA and the public charity in order to verify that the distribution will qualify for favorable tax treatment under the PPA.
An IRA owner who made a qualified charitable distribution in 2006 should have received IRS Form 1099 for the full amount of his or her withdrawal. The IRA owner should report the amount on line 15(a) of his or her 2006 IRS Form 1040 and then report the taxable part (gross distribution minus qualified charitable distribution) on line 15(b), writing “QCD” next to line 15(b). (IRS 2006 1040 Instructions page 25.) The IRS has not published the 2007 income tax returns yet, but presumably the reporting procedure will be the same on the 2007 return.