The American Taxpayer Relief Act of 2012 ("ATRA") extended the qualified charitable distribution (QCD) provisions through December 31, 2013.
In general, distributions from IRAs must be included in gross income in the year in which distribution occurs, and income taxes must be paid on the taxable portion. A qualified charitable distribution ("QCD"or charitable rollover) is not included in income.
A QCD is an otherwise taxable distribution from an IRA (other than an ongoing SEP or SIMPLE IRA) owned by an individual who is age 70½ or over that is paid directly from the IRA to a qualified charity. An IRA owner can exclude from gross income up to $100,000 of a QCD made for 2013, and a QCD can be used to satisfy any IRA required minimum distributions (RMDs) for the year. A married couple could potentially make a $200,000 contribution since the limit is per person. The amount of a QCD excluded from gross income is not taken into account in determining any deduction for charitable contributions so if you are running up the percentage limitation for charitable gifts, using a QCD will allow you to transfer more to charity.
ATRA reinstated the ability of a 70½ year-old individual to make a tax-free IRA distribution or rollover to a charity of up to $100,000 in 2013. The tax law applicable in 2012 did not permit this. It was last available in 2011. There was a unique opportunity available only in the month of January 2013 where an individual could rollover an additional $100,000 and have it treated as though it were rolled over in 2012.
The donee organization cannot be a non-operating private foundation, a supporting organization or a donor-advised fund, and the individual cannot receive any consideration for the distribution. Distributions from employer-sponsored retirement plans such as SIMPLE IRAs and SEPs do not qualify.
Interplay with Social Security
Social Security (SS) income is not taxable until a taxpayer's AGI (without SS income) plus 50% of their SS income plus tax-exempt interest income, plus certain other infrequently encountered additions exceeds a specific threshold. The threshold is $32,000 for married taxpayers filing jointly, zero for married taxpayers filing separately and $25,000 for all others. Once the threshold is exceeded, the SS income subject to tax varies from 50% to 85%.
If a taxpayer is 70½ years of age or over, he of she is required to start taking required minimum distributions (RMDs) from IRAs and most other retirement plans. The amount of the RMD can impact the taxation of the taxpayer's SS benefits. For 2013, a taxpayer aged 70½ and over can make a direct IRA-to-charity distribution which also counts toward the taxpayer's RMD for the year. The distribution is not included in income (therefore does not impact the taxability of the SS income). Obviously, the charitable contribution is not deductible since the distribution from which the contribution was made was never includable in income for the year.
An added benefit occurs when a taxpayer has a substantial charitable contribution and he only marginally itemizes. Donations to charities are tax deductible only when a taxpayer itemizes deductions. By replacing the RMD income and charitable contribution with a direct IRA-to-charity rollover, the taxpayer can contribute to a favorite charity and at the same time exclude the distribution from income and utilize the standard deduction to reduce his taxes.
Avoiding the 3.8% Obamacare surtax
Using the charitable rollover provision would cause one to have less adjusted gross income. Since the new 3.8% Obamacare surtax applies to the lesser of 1) the taxpayer's net investment income (NII) and 2) the taxpayer's modified adjusted gross income (MAGI) reduced by a fixed threshold, reducing adjusted gross income is an important planning strategy. The threshold is $250,000 for married couples filing jointly, $125,000 for married couples filing separately, and $200,000 for everyone else.
Avoiding Limits on Itemized Deductions
Effective January 1, 2013, ATRA has reinstated the "Pease limitation," (named after former Congressman Donald Pease) which had been eliminated for the 2011 and 2012 tax years. That limitation caps the amount of certain itemized deductions, including the charitable deduction, that an individual may take if his or her MAGI exceeds a certain threshold amount called the "applicable amount." The new law has set the applicable amounts as $250,000 for a single individual, $300,000 for a married couple filing a joint return, and $275,000 for head of household. If a taxpayer's adjusted gross income exceeds the applicable amount, the taxpayer's itemized deductions will be reduced by the lesser of 1) 3% of the amount that a taxpayer's adjusted gross income exceeds the applicable amount, or 2) 80% of all itemized deductions that are subject to the Pease limitation for the tax year.
For a high-income donor who makes a large gift to charity, the Pease limitation may significantly reduce the amount of itemized deductions that a donor might otherwise be able to take. Using the charitable rollover can avoid these limitations.
The IRA-to-charity rollover can be a true win-win. The taxpayer can reduce his or her income tax and the charity receives a much-needed contribution.