A Donating your IRA assets to a worthy cause while you are living is a pretty simple undertaking. Just take a distribution and donate it to charity. After all, that's the only way to do it, right? For certain taxpayers, it's not that simple anymore. The recently enacted Pension Protection Act of 2006 (PPA) gives some taxpayers a more attractive alternative.
Under the old rules, when you want to donate IRA assets, you first withdraw cash or assets from the IRA. The withdrawal is taxed as ordinary income, but if you are over age 59 1/2 you don't have to pay the additional 10% early withdrawal penalty. Then, you can make a charitable donation for which you may be able to take a charitable deduction. Unfortunately, the income tax and penalty due on the withdrawal may not be completely offset by the charitable deduction, because charitable deductions are limited. To claim a charitable deduction, you generally must be able to itemize, and then the deduction will be subject to two limiting ceilings.
The first ceiling is based on the type of charity: 50% charity or 30% charity. The percentage refers to the maximum percentage of adjusted gross income (AGI) that may be written off as a charitable deduction in any given year. Unused deductions retain their character and may be carried forward for 5 years. Fifty percent charities include churches, schools, hospitals, endowment foundations, private grant-making foundations, and community chests. Thirty percent charities include veterans' organizations, private non-operating foundations, fraternal organizations, and public cemeteries. IRS publication 78 provides a listing of all recognized 50% and 30% charities.
The second ceiling is based on AGI. When AGI exceeds $150,500 for all filers—except married taxpayers filing separately—for 2006 and $75,250 for married taxpayers filing separately, then charitable deductions are reduced by 2% (for 2006 and 2007; it was previously 3%) of the amount by which AGI exceeds this threshold. Other rules come into play, too. The point is, the charitable deduction will not completely offset the income tax obligation on the IRA withdrawal.
PPA—the new rules—allows certain taxpayers to make tax-free qualified charitable donations of their IRA assets in 2006 and 2007. IRA owners who have attained age 70 1/2 are permitted to take tax-free IRA withdrawals of up to $100,000 annually when the amount withdrawn is donated to a qualified charity. The tradeoff? There had to be one. No charitable deduction is allowed. That's more than fair from these donor taxpayers' point of view because they come out ahead, especially when you consider that the qualified charitable donation may be used to satisfy any required minimum distribution requirement for the tax year.
Some specific criteria must be met for the donation to qualify, however: the qualified charitable donation must be made after the donor taxpayer has attained age 70 1/2, the charity must be qualified, and the withdrawal must be paid directly to the qualified charity from the IRA.
Other requirements can't be addressed adequately in this brief article, and this attractive new law is only in effect for 2006 and 2007.
Many factors must be addressed when deciding whether to make a lifetime donation of IRA assets or non-IRA assets, including the availability or lack of state income tax breaks, the fact that the new law does not apply to donations from a simplified employee pension plan (SEP IRA or Simple IRA), and ability to itemize deductions. When considering whether to take advantage of this law, consult your financial planner.