Qualified distributions from IRAs extended by new law
By Robert Powell, MarketWatch
Last Update: 7:00 AM ET Jan 8, 2013
Many IRA accounts owners would like to donate some of their retirement assets to charity before they die. Well, the new fiscal-cliff law contains some good news for those who have such desires and the wherewithal. The American Taxpayer Relief Act of 2012 has extended for a year the qualified charitable distributions provision that allows them to do that.
I am quite pleased that Congress got a little something right, said Dharmesh Vora of Vora Financial Group.
By way of background, Americans who wanted to donate their retirement assets to charities on a tax-free basis during their lifetime were unable to do so until thePension Protection Act of 2006, according to Denise Appleby, the founder of the Appleby Retirement Dictionary. Before that, the donation was treated as a regular distribution and ordinary income, Appleby noted in a recent post. But the PPA included a provision that allowed eligible individuals to make nontaxable distributions from certain types of retirement plans to eligible charities. Those distributions, or QCDs were limited to $100,000 per year and applied only to distributions that occurred from 2006 to 2011. But the provision was extended under the ATRA, the new fiscal-cliff tax law, according to Appleby.
This is especially good news for those who might not need the income from an IRA for living expenses. The generation that is currently in the Required Minimum Distribution (RMD) stage of their retirement accounts was one of the best generations at saving money, said Vora. They did not live beyond their means. Many have several sources of incomepensions, Social Security, investment incomeand may not have a need for the income from their IRA.
Now this option for donating retirement assets to charity, even with the provisions of PPA, is not open-ended. Its limited to the type of retirement assets that can be gifted, the individuals who are eligible, and the type of charity to which the donation can be made.
Those who want to gift their retirement assets to a charity under this provision must answer these questions: Am I old enough? Does my retirement account qualify? Does the charity qualify?
The answer to these questions will determine eligibility to donate the retirement assets to the charity on a tax-free basis, Appleby wrote in an article that detailed theQCDrules, including the special provisions made under the fiscal cliff bill. Read Donating Retirement Assets to Charities.
Other advisers, meanwhile, shared these points.
Are you old enough?
A taxpayer must be at least 70 years old to do a QCD from an IRA, said Terry Prather, a wealth planner with Payne Wealth Partners. And that, for some reason, is different than when an IRA account must take an RMD. Just because the taxpayer will reach age 70 doesn't mean hes eligible for a QCD, said Prather. He must actually have reached age 70 when the distribution occurs.
Does my charity qualify?
The QCD must go to a qualified charity, which Prather said is the same requirement as deducting charitable donations. Also, the taxpayer is required to obtain an appropriate receipt from the charity, he said.
Hal Rogers of Gold Tree Financial said its likely that the charity you are working with knows the rules, but you cant count on this. His advice: Coordinate any QCDs with your tax return preparer or your financial adviser before initiating the process to make sure you dont overlook a critical step in the actual process of distribution from the plan and contribution to the charity.
By the way, you could be in for a big surprise if the distribution isnt made directly to the charity, said Jeremy Portnoff of Portnoff Financial. If they take the distribution payable to themselves and then give to charity, it doesnt work the same, he said. In such a case they would have to realize the income and then get any applicable charitable deduction. The QCD is much more tax efficient.
Others agree. The bottom line is that, given this opportunity, if an IRA account owner is going to give money to a charity from qualified account, they should use the direct transfer, without showing the income procedure, said Rogers.
Portnoff cautioned, however, against doing a QCD without doing some due diligence. With such recent natural disasters Hurricane Sandy, some IRA owners who might want to give to charities to help victims should be sure they are giving to a qualified charity, he said There are many organizations that pop up to help people, but now all of them will be qualified for purposes of making a QCD.
Is it worth it?
As for whether doing a QCD makes a difference on your tax return is a matter of some debate. Prather, for instance, said the QCD isnt reported as taxable income on the tax return nor is the donation allowable on Schedule A of the tax return as a charitable donation deduction. If the taxpayer supports charity, the QCD essentially allows a tax deduction even if the taxpayer doesnt itemize deductions on Schedule A of his tax return, he said.
And since the QCD isnt included as taxable income, Prather said, it doesnt increase a taxpayers Adjusted Gross Income (AGI). This, he said, can be helpful for many taxpayers provided they meet the qualifications for a QCD, which include the following:
- The amount of Social Security benefits subject to federal income tax is generally based on the individuals other taxable income. As this taxable income increases, more of the individuals Social Security benefits are subject to federal income tax until the maximum 85% of benefits are taxed. If a taxpayer falls within this range, a QCD can cause a lower amount of Social Security to be taxable and therefore reduce his federal income tax liability.
- Lowering ones AGI via a QCD can sometimes limit the phaseout or reduction in several tax deductions. (Schedule A miscellaneous deductions are only deductible above 2% AGI, Schedule A medical deductions are only allowed above a certain percentage of AGI depending on the taxpayers age).
By directing the distribution directly to the charity the taxpayer won't have to report the distribution as income on their tax return, said Vora. In some cases this may allow the taxpayer to remain in a lower tax bracket, not have to pay as much in tax on their Social Security income and obviously reduces the amount of taxes paid overall, Vora said.
Rogers noted that in terms of the taxes due or not due as a result of doing QCD, that you are either showing the income and taking a deduction, or you aren't showing the income, which is allowed under the QDC provision. It would seem at first glance that the net would be the same either way, Roger said.
However, the charitable deduction may be limited by other provisions of the tax code, so the net may not be the same, Roger said. Additionally, showing the income would increase MGI which is before deductions, and can negatively affect the net result in other ways, he said.
Of note, for those who do a QCD, Vora said a 1099-R will be sent to the taxpayer for reporting on their tax return. However, it is up to the taxpayer to indicate how much of the distribution was a QCD, he said. The 1099-R must be recorded on the return. When in doubt or not, he suggested that you consult a tax professional for the proper reporting method.
Odds and ends
Meanwhile, Michael Schwartz, the founder of Schwartz Financial Services, also noted that IRA account owners can do a distribution for 2012 through the end of January 2013. And Joe Felicetti of R. Seelaus & Co. said this a terrific tax break for owners of SEP IRAs who are 70, still working and making contributions, and forced to take RMDs.
This means, Felicetti said, that even if an IRA account owner took an RMD for 2012, they can instruct the IRA custodian to cut a check to a qualified charity by Jan, 31, 2013 and have that count as a QCD for 2012. In essence, they get a tax break on the contribution and the distribution, he said. They get to have their cake and eat it too.
For the record, Prather also said the QCD can be applied toward a portion or all of the taxpayers RMD. And, he noted that the annual maximum amount of a QCD is $100,000 per taxpayer and that a husband and wife can each transfer $100,000 for a total of $200,000.
And Vora noted that the IRA account owner may direct any amount of their RMD to a charity. This is not an all-or-nothing situation, he said.
Of course, doing a QCD works only if someone is charitably inclined, said Portnoff. This also speaks to those who normally give to charity and dont know about the QCD option, he said. If you already give to charity, why not do it in a more tax efficient way such as the QCD.
The bottom line for Rogers is this: If available, use the QCD provision. But make sure the rules are followedand to do this, make sure you do it right to start with and make sure your tax return preparer knows the rules.
Robert Powell is editor of Retirement Weekly, published by MarketWatch. . Follow his tweets at RJPIII.
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