January 21, 2013

A Time-Limited Benefit of Fiscal Cliff Act: Tax-Free IRA Charitable Rollovers

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The American Taxpayer Relief Act of 2012 (ATRA) may have marked the beginning of a new era of higher taxes for most high-income taxpayers, but it also revived the popular tax-free treatment of charitable contributions made directly from IRA accounts. This technique can allow taxpayers to reduce taxable income substantially for both 2012 and 2013.

For clients looking to ease the sting of higher tax rates and limited tax preferences in 2013, the IRA-to-charity transfer can provide an effective strategy, while simultaneously allowing these clients to further their philanthropic goals. For last year’s donations, however, the time to act is now, as the brief 2012 election period is quickly coming to a close.

Tax-Free Charitable Gifts in 2013

ATRA revived a provision that allows taxpayers aged 70½ and older to make tax-free charitable donations directly from IRA accounts. For many taxpayers, this allows them to take their annual required minimum distribution (RMD) from retirement accounts without the corresponding increase in taxable income. The RMD rules require that a taxpayer begin taking distributions from an IRA once that taxpayer reaches age 70½. Because of this, many taxpayers are required to increase their annual taxable income whether they need the extra funds or not.

The tax-free treatment of charitable donations from IRA accounts allows these taxpayers to take their RMD (up to $100,000 per year, or $200,000 per couple if each spouse has a separate IRA) without increasing their tax burden as long as the funds are transferred directly to a qualified charity. This can prevent a taxpayer from exceeding the annual income thresholds for higher tax rates and limitations on deductions and exemptions in 2013.

ATRA brought about tax changes that make minimizing taxable income more important than ever, especially for higher income taxpayers. Lower income levels in 2013 cannot only push a client into a lower tax bracket but can allow the client to avoid limitations on exemptions and itemized deductions, as well as new investment income taxes imposed under the Affordable Care Act.

A Window for 2012 Donations

The provision was made retroactive for 2012, as well, and donors who choose to make gifts in January 2013 are permitted to reflect the donation on their 2012 returns. These donations can be used to satisfy the owner’s 2012 RMD. Further, an IRA owner who waited to take an RMD until December 2012, when the tax-free contribution rule was technically not in effect, can make a cash contribution to a qualified charity in January 2013 and still qualify for this tax-free treatment.

Unless the RMD was taken in December 2012, the transfer is required to be made as a trustee-to-charity transfer, meaning that a check is written directly from the IRA to the charity to qualify for tax-free treatment. This means that the account owner has no control over the funds once they are withdrawn from the account. Further, the charity receiving the funds must be a public charity—donor advised funds and private foundations are excluded.

The gifts cannot be deducted as itemized tax deductions if tax-free treatment is elected, but the income-reducing benefits can make it a smart choice for many IRA owners regardless.

The Clock Is Ticking

As in the past, Congress extended the tax-free treatment of these charitable deductions only through 2013, meaning that it is possible that these benefits could be short-lived. For clients looking to reduce their taxable income for 2012, the election can be made only before February 1, 2013.

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