As we know, life insurance is an important tool in charitable giving. The “multiplier” created by the difference between the premium and the death benefit allows a charitable donor to give more than the premiums paid. That effect will give the organization more capital. For the donor, there is greater satisfaction and far greater recognition.
A provision in the Pension Protection Act of 2006 added ?408(d)(8) to the Internal Revenue Code, which will make it much easier for IRA owners to make substantial charitable gifts with single premium life insurance policies. During 2006 and 2007, the provision allows donors age 70 1/2 and older to make direct rollovers to a qualified charity of up to $100,000 without affecting the donor’s taxable income.
The provision is temporary; there is no indication that it will be renewed for 2008 and beyond. Therefore, IRA owners now have one year remaining to take advantage of this planning opportunity. Let’s look at the benefits of this provision.
Tax benefits of charitable IRA rollovers
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Percentage of Adjusted Gross Income (AGI) Limitation–This is the primary benefit of this new planning opportunity. Under the old rules, if a donor took $100,000 out of an IRA and gave the funds to a charity, the amount first had to be included in gross (i.e., taxable) income. Then the donor got a charitable contribution itemized deduction. The likely problem was that the donor’s contribution deduction would run into the 50% of AGI limitation. That meant the donor would likely not be able to deduct the full $100,000 in the year of contribution.
That would force the donor to pay income tax on the difference between the $100,000 and the deductible amount. Carryover provisions allow the excess contributions to be carried forward for 5 years. Still, the donor would have to prepay some income tax (possibly a lot) and take his or her chances with being able to deduct the excess in future years.
This new provision under the act avoids the donor’s taxable income. The $100,000 is reported as part of gross distributions, but it is not included in the taxable portion. Of course, there’s no charitable contribution deduction, but you can prepay tax and take your chances with carrying over the excess contributions to a future year.
The transaction circumvents the tax return. There is no inclusion in gross income, no charitable contribution deduction and no effect on taxable income. In effect, the taxpayer can deduct the entire $100,000 charitable rollover in the year of the rollover.
Itemized Deduction Phase-Out–At higher AGIs, ?68 IRC phases out itemized deductions. Because the charitable rollover isn’t included in AGI, the new provision reduces the chance the IRA distribution would trigger phase out.
Standard Deduction–Individuals take the standard deduction because their itemized deductions aren’t large enough. Therefore, the standard deduction is more beneficial to them than itemizing. Because the charitable rollover avoids the donor’s tax return, the donor gets both the standard deduction and the charitable contribution deduction.
Effect of AGI–The medical expense itemized deduction has a 7.5% floor, and most miscellaneous itemized deductions have a 2% floor. That is, only the amounts in excess of those percentage floors are deductible. By not being included in AGI, the charitable rollover is prevented from decreasing the amounts of those deductions.
Taxability of Social Security–An increase in an individual’s “provisional income” (?86 IRC, sort of a modified AGI) may make more of the individual’s Social Security benefit subject to income tax. By not being included in AGI, the charitable rollover will not be included in provisional income, avoiding the possibility the charitable rollover would increase the amount of Social Security subject to income tax.
State income taxes–Some states do not allow deductions for charitable contributions. Therefore, the charitable rollover provisions avoid a possible increase in the donor’s state income tax.
Minimum Required Distribution (MRD)–The charitable rollover is included in determining whether or not the MRD has been made. Therefore, if the MRD was $60,000, a $100,000 distribution would satisfy the requirement and the taxpayer wouldn’t have to take any more from the IRA in 2007. Unfortunately, the excess $40,000 cannot be carried over to 2008 to help satisfy 2008′s MRD.
Spouses–The provision applies to each individual’s IRAs. In a marriage, both spouses may have IRAs. If so, each can roll over $100,000 for a combined $200,000 rollover contribution to a single qualified charity.