By Ken Berry
Unless Congress takes action soon, on December 31, 2011, a unique tax break for senior citizens will be wiped off the books. This tax law provision allows qualified taxpayers to "roll over" funds tax-free from an IRA to a charity.
But there's a major drawback to the deal. Unlike a regular charitable gift, the donor isn't entitled to a deduction for the amount of the rollover. In essence, this technique creates a tax return "wash"; however, it can provide other benefits worth considering.
Background: Under the Pension Protection Act of 2006 (PPA), a taxpayer age 70½ or older can choose to transfer funds directly from an IRA to a qualified charitable organization. The annual limit on rollovers is $100,000 per taxpayer. Although no tax deduction is permitted, donors aren't taxed on the distribution either. The PPA provision, which initially expired in 2007, was reinstated and extended through 2009. Recent tax legislation extended the tax break through 2011 and permitted retroactively for 2010.
Note that the distribution must be made directly from the IRA trustee to the charitable organization. In other words, the taxpayer can't use the funds and then transfer the cash to the charity. It has to be a straight shot.
In addition, the contribution must otherwise qualify as a tax-deductible charitable donation. For instance, if the deductible amount would be disallowed due to inadequate substantiation or would be decreased because the donor received a benefit in return, the tax exclusion wouldn't apply to any part of the IRA distribution.
Be aware that a rollover can be made from a Roth IRA if a portion of the distribution would be taxable (e.g., distributions from a Roth in existence fewer than five years). In general, it makes sense to exhaust the funds in a traditional IRA first. Subsequent distributions from a Roth may be tax-free of their own accord.
Extra benefit: Once your clients reach age 70½, they must begin taking Required Minimum Distributions (RMDs) from their IRAs. RMDs are taxed at highly taxed, ordinary income rates. Failing to take an RMD generally results in a penalty equal to 50 percent of the amount that should have been withdrawn; however, the amount rolled over from an IRA to charity counts as an RMD. Therefore, your clients can meet this requirement without paying tax and contribute to a worthy cause at the same time.
Furthermore, a client may benefit from this technique if charitable deductions would otherwise be limited by other tax law provisions. Finally, the tax-free rollover may effectively lower the tax that a retiree must pay on Social Security benefits and reduce a client's adjusted gross income (AGI) for various other tax purposes.
Update: Several proposals kicking around the nation's capital would extend the charitable rollover break again. Nevertheless, at this point, nothing is certain.