Time may be running out on a unique estate-planning strategy for retirees. Under a special tax-law provision, an individual age 70½ or older can transfer funds directly from an IRA to a qualified charitable organization while paying zero tax on the distribution. Such a “charitable rollover” also counts as a required minimum distribution (RMD) for tax purposes.
Currently, the charitable rollover break is scheduled to expire at the end of the year, so timing can be critical. Even if it is eventually extended by late year-end legislation, as has occurred in the past, you might choose to take advantage of this opportunity in 2013.
Background: Previously, you could not directly transfer funds tax-free from an IRA to a charitable organization. Instead, you were required to pay tax on the distribution, regardless of your charitable intentions. The tax law also worked against retirees who wanted to use IRA funds for charitable donations but no longer itemized their deductions.
However, the Pension Protection Act of 2006 (PPA) changed the rules for individuals age 70½ and older. It allowed these retirees to transfer IRA funds directly to charity, up to an annual limit of $100,000. Although no tax deduction was allowed, donors were not taxed on the distribution either. The PPA tax break was subsequently extended through 2009, then through 2011 by the 2010 Tax Relief Act. Finally, the new American Taxpayer Relief Act of 2012 (ATRA) reinstated the rules, retroactive to 2012, and extended them through 2013.
A qualified distribution is defined as one from either a traditional or Roth IRA that would otherwise be taxable. The distribution must be made directly from the IRA trustee to the charity.
Furthermore, the contribution must otherwise qualify as a charitable donation. If the deductible amount decreases because of a benefit received in return—a dinner at a fund-raising event, for example—or the deduction would not be allowed due to inadequate substantiation, the exclusion is not available for any part of the IRA distribution.
Under a special rule for charitable donations, the IRS treats distributions from an IRA funded at least partially with nondeductible contributions as coming first from taxable funds and then from nontaxable funds. All of the individual’s IRAs are grouped together for this calculation.
Finally, an IRA participant is generally required to begin receiving RMDs in the year after the year in which he or she turns age 70½. A qualified charitable distribution counts toward this requirement.
Note that the same technique may be used for Roth IRAs. Roth IRA distributions to individuals older than age 59½ are often tax-free. But a portion of a distribution may be taxable for a Roth in existence less than five years. If you have both a traditional IRA and a Roth IRA, it generally makes sense to use the traditional IRA first for charitable distributions.
Reminder: The charitable rollover technique is not for everyone. To see if it makes sense for your family’s situation, seek expert guidance.