By Andrea Coombes, MarketWatch
Last Update: 4:02 PM ET Oct 20, 2006
This update clarifies that tax-free charitable distributions from IRAs for those 70 1/2 and older are not necessarily free of state taxes.
SAN FRANCISCO (MarketWatch) — Charitable giving got a lot easier for some taxpayers — and harder for others — thanks to some tax-law changes in the recent Pension Protection Act.
The good news is taxpayers who are 70 1/2 or older can take up to $100,000 out of their IRA tax-free this year and next, as long as they donate it to a qualified charity.
Meanwhile, taxpayers of all ages face slightly stricter rules when it comes to deducting charitable donations: Next year we’ll have to make sure we document any monetary donations, even if less than $250. And, starting this year, those donating clothing or household goods will need to make sure the items are of “good or better” quality.
The real windfall is for those charitable givers who are in their 70s and who’ve got hefty IRA assets. Now they can “take out up to $100,000 per year, give that to charity and not have to include that in income,” said Jere Doyle, senior vice president of wealth management for Mellon Financial’s private wealth management group, in Boston.
Plus, that charitable donation counts toward the required minimum distribution that qualified plans require of those 70 1/2 and older.
The perk exists only this year and next, and the limit each year is $100,000. To take full advantage of the new law, people need to hurry. “There’s only a limited period of time left in this year when you can do this,” Doyle said.
“This is not going to be a gift they can make on Dec. 31. Most [IRA firms] will have cut-off dates after which they will no longer cut a check from an IRA. I would expect most institutions will set a drop-dead date of no later than Dec. 15.”
Another possible restriction: Some IRA account managers may refuse to offer the perk for small donations, less than a few thousand dollars, to avoid the administrative costs of writing many checks.
“One of the concerns is, will the institution say, ‘We’ll only do it if the distribution is over a certain amount of money,'” Doyle said.
Other rules to consider:
Taxpayers should not take a distribution from their IRA and then write a check to the charity. To be tax-free, the distribution must go directly from the IRA to the charity.
The new rule applies only to IRAs, not other qualified plans.
You must already be 70 1/2 years old when you make the contribution.
The donation must be a made to a public charity, and in this case donor-advised funds do not count as a public charity.
If you use this perk to withdraw IRA funds tax-free, you can’t then also deduct that money on your tax return as a charitable donation.
Boon for high-income taxpayers
All taxpayers can benefit from the tax-free IRA distribution (assuming their donation is large enough for their IRA account manager to honor the request), but high-income taxpayers gain the greatest benefit, said Charles Pomo, a certified public accountant and director of the individual tax group at Geller Family Office Services, an investment advisory firm in New York.
That’s because taxpayers with high income often lose 2% of their itemized deductions due to income phase-outs. But under the new law they can tap as much as $100,000 of their required IRA distribution without that money counted in income, he said.
Thus, “their AGI would be reduced by $100,000 that would normally be considered taxable. Indirectly, it’s increasing the value of their deductions,” he said.
“If somebody has an IRA in the millions of dollars, the [required minimum] distribution itself could exceed $100,000. This really works for the charitably inclined person,” he said.
The new law helps those who donate less, such as $1,000 or $5,000, he said. “There’s still a benefit, but the reality is it works really, really well for the high-income taxpayer.”
Plus, taxpayers in states which don’t allow itemized deductions might have even more to gain, Pomo said. That’s because, before the change, an IRA distribution given to charity would get hit by state income tax with no off-setting charitable deduction on the state return. Under the new federal law, it’s possible that donation will be state-tax free as well. But it’s important to note: The tax free treatment of these IRA distributions may not be available for state income tax purposes in all states. Check with your tax expert or state tax department.
Note to self: Improve record-keeping
The Pension Protection Act also made changes related to how taxpayers document their cash and clothing donations.
Before the new law, taxpayers did not need to document monetary donations less than $250. Starting in 2007, taxpayers will need to keep receipts documenting all monetary donations they claim as a charitable deduction on their tax return.
“Now, for any monetary gift, you need a bank receipt or written acknowledgement from the charity, including charity’s name, the date of the gift, the amount of the gift,” Pomo said. A cancelled check or a credit card statement will also suffice, he said.
Taxpayers’ best bet is to avoid cash donations and instead focus on check or credit card payments, he said.
Taxpayers don’t send these receipts to the IRS, but simply keep with their records in case of an audit.
Only the best, or at least ‘good’
The new rule for clothing and other household donations goes into effect for 2006.
“The rules were tightened a bit to counteract what the IRS saw as somewhat heightened value claims,” Pomo said. Now, “clothing and household items must be in what they call good or better condition to qualify for that deduction.”
The law does not specify what “good” or “better” means, but taxpayers might consider taking photos of the items or getting a written acknowledgment from the charity that the items are in such condition.
Pomo recommends making a detailed list of the items, such as “three pairs of pants, two shirts.” Then the charity can acknowledge the exact items were received in “good,” or better, condition.
Andrea Coombes is a reporter for MarketWatch in San Francisco.