Individuals

IRA Distributions to Charities

Pension Protection Act of 2006 (PPA ’06) Section 1201(a) added Sec. 408(d)(8), introducing the concept of qualified charitable distributions from IRAs. For 2006 and 2007 only, taxpayers over age 70½ can instruct an IRA trustee to make direct gifts of up to $100,000 to qualified charities, without having to report the IRA distributions as income on their Federal tax returns. Because these distributions will not be included in income, the donor cannot take a charitable deduction.

Using IRA distributions to make charitable gifts may be more advantageous than traditional gifting. Outside of the two-year window, the taxpayer must take a taxable distribution from the IRA and report the income; a donation is reported as an itemized deduction subject first to the charitable deduction limits, then to the itemized deduction phaseout. The additional income may not be offset by the deduction because of the complexity of the tax law (primarily, the alternative minimum tax and the limits on deductions).

Limited Scope

Although the new provision is an excellent opportunity for older taxpayers to contribute retirement plan assets to charity without recognizing income, its scope is limited. Ideally, the IRA distribution will be a required distribution not otherwise needed by the donor. The provision is valid for only two years and is limited to $100,000 each year. The donor must be over 70½ and the recipient must be a qualifying charity; donor-advised funds and private foundations do not qualify. Qualifying charities are defined in Sec. 170(b)(1)(A) as churches, educational institutions, hospitals and other similar entities. The IRA trustee must make the distribution directly to the qualifying charity.

No benefits can be received in exchange for the donation and taxpayers must meet all substantiation requirements. (The PPA ’06 also added more stringent recordkeeping requirements for charitable contributions. Its changes codified the rules in the regulations specifically addressing the need for bank records and/or receipts from the charitable organization; for a discussion, see Krumwiede and Witner “Substantiation Rules for Charitable Gifts, this issue.”

Opportunities/Strategies

While the provision has a rather narrow scope, it should appeal to a broad variety of taxpayers. Medium-income taxpayers can mitigate the taxation of Social Security benefits by excluding required minimum distributions (RMDs) from income. Tax-payers who use the standard deduction can use the provision to eliminate an RMD from taxable income and effectively take a charitable deduction, plus the standard deduction. Higher-income taxpayers will realize that the contribution is 100% deductible on a pre-tax basis, because of the adjusted-gross-income limits on itemized deductions and the 50% limit on contributions. By making a direct IRA contribution to charity, some taxpayers may be able to use charitable contribution carryforwards from prior years.

Tax advisers will have to analyze, on a case-by-case basis, the benefits of using highly appreciated securities versus direct IRA distributions. They will also have to address state tax issues, as some states allow itemized deductions and others already exclude all (or a portion of) retirement income. Making contributions from a Roth IRA may have fewer advantages, but it will still avoid the normal limits on charitable contributions. For distributions from retirement plans other than IRAs, the funds must first be rolled over to an IRA, then the IRA distribution must be made directly to the charity by the trustee.

From Rosemary F. Ervin, CPA, Hunter Group, Fairlawn, NJ