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IRA Makes Gift of
a Lifetime
Frequently Asked Questions - Charitable IRA
Why do donors want to give IRA
assets to the Community Foundation?
After decades of deliberate saving and
favorable investment returns, some retirees have more money in their
IRAs than they’ll ever need. For larger estates, a good portion of IRA
wealth goes to estate taxes and income taxes of non-spousal
beneficiaries; heirs may receive only 25 percent to 30 percent of IRA
assets passed on to them through estates.
Instead, IRA holders may choose to leave
their IRAs to qualified charitable organizations—choosing charity over
taxes.
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Which donors
stand to benefit most from giving their IRAs to charity?
Because charitable
IRA transfers are not included in taxable income and not available for
itemized charitable deductions, these special rules may benefit many
different types of individuals:
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High-income earners—Donors who itemize deductions may find
that they cannot take full advantage of their tax deductions. Often
referred to as the 3 percent floor, a taxpayer must reduce itemized
deductions by 3 percent of the amount by which the taxpayer’s
adjusted gross income exceeds a certain amount that is adjusted
annually for inflation (currently $150,500 or $75,250 each for
married people filing separately). For the years 2006 and 2007, the
reduction on itemized deductions for affected taxpayers is reduced
by one-third.
Example: In the 2006 tax year, a married couple filing jointly has
$1,000,000 in adjusted gross income (AGI). Because the couple’s AGI
exceeded $150,500, the phase-out rules will apply to the couple’s
itemized deductions. A complex formula shows that the couple’s itemized
deductions will be reduced by $16,990 and, as a result, the couple can
claim $133,010 in itemized deductions. Presuming the couple’s tax rate
is 35 percent, the reduction in itemized deductions potentially results
in additional taxes of approximately $5,945. (Note that this is a
simplified example; please see your professional tax advisor for how it
may affect you.
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Generous
donors—When making a major gift, some taxpayers may give
more to charity than they can deduct that year. Donors cannot deduct
more than 50 percent of their income for gifts of cash to public
charities (30 percent, if giving to private foundations). Although
amounts over 50 percent can be carried forward and deducted in
future years, taxpayers will face an immediate tax bill and may lose
some of the benefit of the deduction if they die before the gift has
been fully deducted. Donors who consistently give above the limit
will not be able to take advantage of the carry forward provisions.
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Non-itemizers—Donors who regularly give a portion of their
income to charity are not able to enjoy a tax break from the
contribution because the standard deduction is still greater than
the total of all itemized deductions. This may be especially true if
state and local income taxes are low.
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Financially comfortable—Individuals or couples who
distribute the minimum from their IRA—and have other forms of income
to pay living expenses—may find that transferring their minimum
distributions to the Community Foundation helps fulfill personal
charitable goals, tax-free.
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In the past, how did the tax law
treat charitable gifts made from IRAs?
Under past law, IRA holders faced a
disincentive for giving retirement assets to charity during their
lifetimes because all withdrawals from traditional IRAs were subject to
income tax. Thanks to the new tax provision, retirees will be able to
give far more support without being penalized, doing so during their
lifetimes and seeing their gifts benefit their communities.
In the past, when a donor of any age
withdrew IRA funds to make a charitable gift, he or she was liable to
pay income tax on the withdrawal, offset to varying degrees by a
charitable deduction for the gift. (Charitable deductions are limited by
legal restrictions, such as the percentage of adjusted gross income [AGI]
limitation on charitable deductions and the 3 percent floor on all
itemized deductions. If an individual does not itemize on his or her
income tax return, no charitable deduction can be taken.)
As a consequence of this unfavorable tax
treatment, very few individuals donated IRA funds to charity during
their lifetimes.
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How has the tax law changed?
The Pension Protection Act
of 2006 permits individuals to transfer up to $100,000 from individual
retirement accounts directly to a qualifying charity without recognizing
the assets transferred as income for federal tax purposes. In tax years
beginning after December 31, 2005, a donor who has reached age 70½ is
now allowed to exclude from his or her income tax calculations certain
IRA withdrawals. In most circumstances, these charitable contributions
are not tax deductible unless the retirement accounts were funded with
after-tax dollars.
This provision is
time-limited. It will not apply to any distribution made in taxable
years beginning after December 31, 2007.
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What are the advantages of this new
law?
The tax benefits now
available to American seniors will encourage new contributions from
individuals who will no longer have to pay tax on a charitable gift of
IRA funds. When given through your Community Foundation, these
contributions can support all aspects of community well-being: arts and
culture, community betterment, education, health, and human services,
and more.
Now it is easier than ever
for more people to enjoy the experience of making the tax-free gift
of a lifetime using their excess retirement assets.
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What if a
donor contributes more than $100,000 from an IRA?
Because the amount
that the donor is able to exclude from income is limited to $100,000
under the act, the remaining amount would be recognized as income.
Within a married couple, each person can transfer $100,000 from his or
her account. A $100,000 charitable distribution may be made in 2006 and
again in 2007.
Donors may choose
to contribute additional amounts to charity; however, the extent to
which additional amounts can be deducted from their income will be
determined following general rules of itemized deductions where the
charitable percentage limitations and itemized deduction reduction are
factors.
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Does a donor
also receive a charitable deduction when he or she transfers assets to a
charity under this provision?
No. The benefit
under this provision is that the individual does not realize the amount
contributed directly from the IRA to a qualifying charity. Because a
donor does not include the amount in his or her gross income, the
individual may not take a charitable contribution deduction for the
contribution. To do so would allow a donor to receive a double benefit
from the contribution. For this reason, charitable contribution
deductions are explicitly prohibited.
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How will
charitable distributions affect the minimum required distributions from
a taxpayer’s IRA?
Shortly after an
individual reaches age 70½, he or she is generally required to receive
distributions from his or her traditional IRA. Distributions from an IRA
to a charity will receive the same treatment as distributions to the
individual taxpayer for the purposes of minimum required distributions.
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Are there any
IRA transfers that do not qualify for preferred tax treatment?
Yes. Transfers to
Supporting Organizations and Donor Advised Funds do not qualify. In
addition, split interest gifts, such as Charitable Annuities, Charitable
Lead Trusts and Charitable Remainder Trusts, do not qualify. Further, an
individual may not receive a benefit in return for an IRA distribution.
Because such
transfers do not count as qualified distributions under these special
rules, the donor will have to first recognize those distributions as
income. The donor’s charitable deduction must then be calculated as a
regular itemized deduction.
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How can an IRA gift be made?
IRAs are typically held by a financial
service or trust company. These custodians will likely provide a form
that could be used to transfer the IRA directly to charity, with no tax
incurred.
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Still have questions?
Please contact us at
qacf@adams.net or at (217)
222-1237.
Back
The
information provided here is based on continuing analysis of the Pension
Protection Act of 2006. Every effort has been made to ensure accuracy of
the answers to these questions. However, due to the complexity of the
bill and the fact that many of these provisions introduce issues that
are new to the Internal Revenue Code, this information may be subject to
change. It is not a substitute for expert legal, tax or other
professional counsel and we strongly encourage donors to work with their
professional advisors to determine the impact of this legislation on
their particular situations. This information may not be relied upon for
the purposes of avoiding any penalties that may be imposed under the
Internal Revenue Code.
©2006
Council on Foundations and Community Foundations of America
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