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Qualified Charitable Contributions from IRAs

January 28, 2013

If you’ve reached 70½, the just-passed fiscal cliff legislation allows you to make cash donations to IRS-approved charities out of your IRA. These so-called Qualified Charitable Distributions (QCDs) were allowed in the past, but the privilege expired at the end of 2011. The new law retroactively resurrects QCDs for 2012 and extends them for 2013. As you will see, they can be a tax-smart deal, but you must take action by the end of this month to benefit from the retroactive options for 2012. Here’s what you need to know:

Qualified Charitable Distribution Basics

QCDs come out of your traditional IRA free of any federal income hit. In contrast, other IRA distributions are taxable. Unlike garden-variety cash donations to charities, you can’t claim itemized deductions for QCDs. That’s okay because the tax-free treatment of QCDs equates to a 100% deduction, as you’ll never be taxed on those amounts, and you don’t have to worry about restrictions that apply to itemized charitable write-offs.

If you inherited an IRA from the deceased original account owner, you too can do the QCD drill if you’ve reached 70½.

A QCD must meet all of the following tax-law requirements:

  • It must be distributed from an IRA, and it cannot occur before you, as the IRA owner or beneficiary, are 70½.
     
  • The funds must be transferred directly from your IRA trustee to the charity. You cannot receive the funds yourself and then make the contribution to the charity. However, the IRA trustee can give you a check made out to the charity that you then deliver to the charity.
     
  • You must get and keep substantiation of the contribution from the charity. Also, you must not have received any benefit (such as tickets to an event) in return for making the contribution. Beware of this rule!
     
  • It must be a distribution that would otherwise be taxable. A Roth IRA distribution can meet this requirement if it’s not a qualified (meaning tax-free) distribution. However, making QCDs out of Roth IRAs is usually inadvisable for reasons explained later.

$100,000 Annual Limit Applies

There’s a $100,000 limit on total QCDs for any one year. But if both you and your spouse have IRAs, each of you is entitled to a separate $100,000 limit, for a combined total of $200,000, even if you file jointly.

Tax-Saving Advantages

The QCD strategy has at least four potential tax-saving elements.

  1. QCDs are not included in your Adjusted Gross Income (AGI). This lowers the odds that you will be affected by various unfavorable AGI-based rules — such as those that can cause more of your Social Security benefits to be taxed, less of your rental estate losses to be deductible and more of your investment income to be hit with that new 3.8% Medicare contribution tax. Also, QCDs are exempt from the rule that says your itemized charitable write-offs for the year cannot exceed 50% of AGI (any excess donations are carried forward for up to five years). Connecticut, and many other states base their income on adjusted gross income.
     
  2. A QCD from a traditional IRA counts as a distribution for purposes of the required minimum distribution rules. Therefore, you can arrange to donate all or part of your 2013 required minimum distribution (up to the $100,000 limit) that you would otherwise be forced to receive and pay taxes on.
     
  3. If you own one or more traditional IRAs to which you have made nondeductible contributions over the years, your IRAs consist partly of a taxable layer (from deductible contributions and account earnings) and partly of a nontaxable layer (from those nondeductible contributions). Any QCDs are treated as coming straight from the taxable layer. Any nontaxable amounts are left behind in your IRA(s). Later on, those nontaxable amounts can be withdrawn tax free by you or your heirs.
     
  4. QCDs reduce your taxable estate.

January 31 Deadline for Retroactive 2012 QCD Options

As stated earlier, the fiscal cliff law retroactively restores the QCD privilege for 2012. To take advantage of the retroactive deal, you have two options.

  1. You can donate IRA distributions that were paid to you last month (December 2012) to IRS-approved charities and then treat those distributions as 2012 QCDs (subject to the $100,000 limit for 2012). However, to take advantage of this option, you must transfer the money to one or more eligible charities by no later than January 31. (This is a limited exception to the rule that the QCD must be made directly from the IRA to the charity.)
     
  2. You can choose to treat QCDs made from your IRA during this month (January 2013) as 2012 QCDs (subject to the $100,000 limit for 2012). In this case, the money must be distributed directly by the IRA trustee to an eligible IRS-approved charity. You cannot receive the funds yourself and then make the contribution to the charity.

Whether you take advantage of these retroactive 2012 QCD options or not, you can arrange for up to $100,000 worth of QCDs this year and treat them as being made for your 2013 tax year.

Are You a Good QCD Candidate?

If you can afford to donate IRA money, you can benefit tax-wise if you match one or more of the following profiles:

  • You don’t itemize deductions (under the normal rules, only itemizers get any income tax benefit from charitable donations).
  • You itemize, but your charitable donation deductions for 2013 would be delayed by the 50%-of-AGI restriction or partially phased out because you’re a high-income taxpayer.
  • You want to avoid being taxed on the required minimum distributions that you must take from your IRA.
  • You are looking for a super-simple estate tax reduction strategy.

If you’re interested in the tax-smart QCD strategy, contact us for full details. Don’t forget about the January 31 deadline for taking advantage of the retroactive 2012 QCD options.

Copyright © 2013 Thomson Reuters/Practitioners Publishing Company.
 

 

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