Directly Out Of Your IRA
For Income And Estate Tax
you've reached age 70 1/2, there's a new tax saving
opportunity you might be interested in if you have
philanthropic inclinations: The Pension Protection Act of
2006 now permits you to make cash donations to many
tax-exempt charities directly out of your traditional or Roth
How the Old Rules
Before the Pension Protection Act, an
individual who wanted to donate money out of an IRA had
to take a withdrawal from the account, include the
taxable withdrawal amount in gross income, donate the
cash to charity, and then claim an itemized charitable
deduction on Schedule A of Form 1040.
Unfortunately, the itemized
deduction phaseout rule and the 50
percent-of-adjusted-gross-income (AGI) limitation often
caused the allowable write-off for the donation to be
less than the income
triggered by the IRA withdrawal. In addition, the income
from the withdrawal could cause you to lose out on other
tax breaks based on AGI.
unfavorable old rules will kick back in after 2007,
unless Congress extends the charitable distribution
Meanwhile, the strategy
described in this article allows you to avoid the old
rules for this year and next, subject to the $100,000
limitation for each year.
favorable new qualified charitable distribution rule is only
available for IRA payouts during 2006 and 2007. No more than
$100,000 can be donated under the new rule in either of those
If you make a “qualified charitable distribution” to a
charity directly from your IRA, the amount is
federal-income-tax-free to you, but you get no itemized
charitable write-off on your Form 1040. That’s okay, because
tax-free treatment of the distribution equates to an immediate
100 percent deduction, without having to worry about tax-law
restrictions that can reduce or delay itemized write-offs. As
you will see by reading this article, the new rule offers some
other important tax-saving advantages as well.
“Qualified charitable distribution” means the payment of an
otherwise taxable amount by a traditional or Roth IRA trustee
directly to a qualified public charity.
Here are five income and estate tax
advantages of this strategy:
charitable distributions are not included in your adjusted
gross income (AGI). This lowers the odds that you’ll be
affected by various unfavorable AGI-based phaseout rules —
such as the rules that can cause you to lose out on your
itemized deductions (including those for charitable
donations), passive losses from rental real estate
activities, personal exemption write-offs, and so forth.
don’t have to worry about the 50 percent-of-AGI limitation
that can delay your itemized deductions for cash donations
to public charities.
qualified charitable distribution from a traditional IRA
counts as a payout for purposes of the required minimum
distribution rules. Therefore, you can arrange to donate all
or part of your 2006 and 2007 required minimum
distribution amounts (up to the $100,000 annual limit) that
you would otherwise be forced to receive and pay income
you own one or more traditional IRAs that you’ve made
nondeductible contributions to, part of your IRA balances
are taxable amounts (from your deductible contributions and
account earnings) and part are nontaxable amounts (from your
nondeductible contributions). In this situation, qualified
charitable distributions are treated as coming from the
taxable amounts first. This is contrary to the “normal” rule
that says IRA distributions are treated as being partly
taxable amounts and partly nontaxable returns of your
nondeductible contributions. Being allowed to pull out
taxable amounts first for qualified charitable distributions
works to your advantage. Reason: It allows you to
completely avoid taxes on otherwise taxable amounts that are
distributed from your IRA to charity, while leaving
nontaxable amounts in your account that you can
withdraw tax-free later on.
but not least, qualified charitable distributions will
reduce your taxable estate.
If you’re interested in taking advantage of this strategy
for 2006, you need to plan with your tax adviser to arrange
for the money to be paid out from your IRA trustee to
qualifying charities by the end of the year.
Bottom Line: The
new qualified charitable distribution rule is beneficial for
taxpayers age 70 1/2 or older in the following circumstances:
- You don’t itemize. (Under the normal rules, only
itemizers get a tax benefit for charitable donations.)
- Your itemized charitable donations would be reduced by
the itemized deduction phase-out rule or delayed by the 50
- You want to avoid being taxed on required minimum
distributions that you are forced to take from your IRA.
- You’re looking for a quick and easy estate tax reduction
Federal-income-tax-free qualified charitable distribution
treatment only applies when the entire amount distributed from
your IRA would otherwise be fully deductible under the
“normal” rules for itemized charitable donations (ignoring the
itemized deduction phaseout rule and the 50 percent-of-AGI
limitation). Therefore, if you receive any benefit from a
charity that would reduce your deduction under the “normal”
rules, you’ll lose the desired tax-free treatment for your IRA
distribution. So be careful to avoid this problem.
Also, you cannot take advantage of the qualified charitable
distribution rule for payouts from a SEP, SIMPLE IRA, or any
other tax-favored retirement plan account.
Finally, the idea of taking qualified charitable
distributions out of a Roth IRA is not nearly as attractive as
taking distributions out of a traditional IRA.
Reason: You or your heirs can take
federal-income-tax-free Roth IRA withdrawals after the account
has been open for at least five years. So with a Roth IRA, the
only obvious advantage to the qualified charitable
distribution strategy is that it will reduce your taxable
|Example: Let's say you’re
71-years-old and financially comfortable. You have
$120,000 in one traditional IRA and $90,000 in another
traditional IRA, for a combined total of $210,000 in the
two accounts. You’ve made a total of $35,000 in
nondeductible contributions to the accounts. The
remaining $175,000 is from deductible contributions and
Before the end of 2006, you decide to
take advantage of the new qualified charitable
distribution rule by donating $100,000 out of IRA Number
One (leaving a balance of $20,000 in that account).
The qualified charitable distribution is
treated as coming out of the taxable portion of your
IRAs. So after the distribution, your IRA balances total
$110,000 ($20,000 in IRA Number One and $90,000 in IRA
Number Two). Of that $110,000, $75,000 is taxable money
(the original $175,000 minus the $100,000 donated to
charity), and $35,000 is nontaxable money (the entire
amount of your nondeductible contributions).
The $100,000 qualified charitable
distribution is more than enough to fulfill your 2006
required minimum distribution obligation for your IRAs,
but you owe no federal income tax. This equates to an
immediate 100 percent write-off for the $100,000. In
addition, your required minimum distribution obligations
for future years have been substantially reduced because
the amount in your IRAs has been reduced by $100,000.
And you still have the entire $35,000 of nontaxable
money in your IRAs, which you or your heirs can withdraw
tax-free later on. Last but not least, you’ve lowered
your taxable estate by $100,000.
In 2007, you can make another qualified
charitable distribution, if you
This new strategy can be a
tax-smart move for well-off taxpayers age 70 1/2 or older.
However, call us at (856) 665-212 before going forward to
ensure it is right for you and the rules are properly