CHARITABLE GIVING FROM YOUR IRA
UNDER THE PENSION
PROTECTION ACT OF 2006
Under the new Pension Protection Act of 2006, one who is
over 70.5 years of age can cause a distribution to be made from their IRA to a
charity that will not cause any income to be taxed to the donor and will cause
otherwise taxable amounts remaining in the IRA to be significantly
reduced. It is called a Qualified
Charitable Distribution or “QCD.”[1]
Current Law. Under existing law, amounts attributable to employer contributions and investment earnings paid from a traditional IRA are taxable to the IRA owner when made, whether made directly to the owner or to some other party. If the owner has made non-deductible contributions to the IRA, he or she is allowed to recover these amounts tax free as a fraction of each distribution. Distributions from Roth IRAs (contributions to which are from after-tax assets of the owner/beneficiary) are not subject to Federal income tax.
Need for a Change. For several years charities and their advisors have been trying to get Congress to permit individuals who own IRAs to make distributions from them to charity without incurring unfavorable tax results, and hopefully obtaining even greater tax benefit. One who is over age 59˝ and takes a distribution from his or her traditional IRA could always contribute the funds to charity, but was subject to the 3% of adjusted gross income reduction on the amount he or she could deduct for those gifts. If the IRA trustee normally withholds at the 10% rate on distributions, there is another problem; the donor would have to come up with that 10% in cash to fund the gift before the end of the year of the distribution. It was even hoped that distributions from IRAs could be used to support the issuance of Charitable Gift Annuities and other similar benefits, such as income payments from Charitable Remainder Trusts. Some of these efforts were successful; others were not (or at least have not yet been) successful.
Favorable Treatment – Let Me Count the Ways.
(i) QCDs are not treated as income of the IRA owner who suggested[2] they be made. This is a departure from the usual “assignment of income” rule taxing a person who has the right to receive funds without penalty but instead directs them to someone else (usually someone in a lower tax bracket, having losses to use or exempt from taxes all together – the later is the case with the recipients of QCDs).
(ii) QCDs count toward the owner’s mandatory payout requirement.
(iii) QCDs are not subject to the 50%, 30% or 20% limitation on annual deductible contributions, and it appears that they do not count against those limits either; by the same logic, however, the IRA’s owner should not increase his or her adjusted gross income by QCDs when calculating his or her contribution base.
(vi) QCDs are considered to be made first from ordinary income, whereas if the are any non-deductible employee contributions in an IRA, they are normally carried out pro rata in each distribution to beneficiaries. For related reasons, Roth IRAs are less attractive for making such distributions, since those funds can be taken out tax free by the owner and used as he or she wishes.[3]
Who are Likely Candidates for Making QCDs.
(i) Individuals who already are approaching the percentage limits on their direct charitable donations (since those limits do not apply to QCDs);
(ii) Non-Itemizers, since QCDs are largely outside the normal income and deduction regimen of Code § 61, 63 and 170;
(iii) Individuals who have large IRAs that hold rollovers from other qualified plans; and
(iv) Individuals whose IRAs have over $200,000 in amounts that would be treated as ordinary income if distributed; an individual who has just rolled over a 401(k) plan balance composed mostly of non-deductible employee contributions would not be a good candidate, since these funds could be drawn out tax free.
Dollar Limitation on QCDs. Up to $100,000 per year distributed as
provided below qualifies for this favorable treatment; amounts in excess of
this amount presumably are treated under the old rules. Query: If more than this amount is distributed to a
qualifying charity in a lump sum, can the portion up to $100,000 be treated as
a QCD? What about the second $60,000
distribution in a single year?
Qualifying Distributees. Any organization described in Code § 170(b)(1)(A) other than donor advised funds or supporting organizations can receive a QCD. So can a private operating foundation and a “pass through foundation” that makes qualifying distributions of 100% of the contributions it receives within 2˝ months after the close of its taxable year. Neither private foundations, supporting organizations (described in Code §509(a)(3)) nor donor advised funds can receive QCDs. DISTRIBUTIONS TO CHARITIES THAT MAINTAIN DONOR ADVISED FUNDS CAN QUALIFY (but donor advised accounts cannot be set up with QCDs).
Distributions that do not Qualify. Unfortunately, several kinds of distributions, even though made from qualified retirement plans to a qualifying distributee, are NOT QCDs:
(i) DISTRIBUTIONS FROM EMPLOYER SPONSORED PLANS CANNOT BE QCDs. Thus distributions from a 401(k) or pension plan, SIMPLE IRA or SEP cannot qualify; only distributions from traditional IRAs and Roth IRAs can be QCDs.
(ii) Even when made from traditional or Roth IRAs, DISTRIBUTIONS THAT CONFER BENEFIT ON ANYONE, THE DONOR, HIS OR HER SPOUSE OR ANYONE ELSE, ARE NOT QCDs. For this reason, IRA distributions that satisfy pledges, even though unenforceable under local law, should be avoided. More importantly, despite pre-enactment talk to the contrary, under the new law a distribution that resulted in the charity paying a Charitable Gift Annuity to anybody would NOT qualify for favorable treatment. Nevertheless, it is possible for both you and a public charity to benefit from a distribution you are required to take from your IRA. (See “Old Fashioned IRA Giving” below).
(iii) Those for whom the DONOR DOES NOT
OBTAIN SUBSTANTIATION. Marc Hoffman, in his excellent article on the
Old Fashioned IRA Giving. Let
us say that you are over 70.5 years of age, retired and must take a
distribution this year of $10,000 from your traditional IRA. All of the
amounts in your IRA were deductible contributions made to an employer’s 401(k)
program that has less investment flexibility than your new IRA. Your marginal tax rate (what you pay on the
next dollar of income you receive before the distribution for both federal and
state income taxes) is 28%. When the distribution is made, whether to you
or charity, you would have to pay $2800 in tax, and if it were paid to you, you
would receive $7200 net.
Now if you take that $7200 and contribute it to charity in exchange for a Charitable Gift Annuity that will pay you an annuity worth half of that amount, you will still get an immediate tax deduction of $3600, which would be worth $1008 in tax savings, and would receive payments each year, quarter or month that would depend upon your precise age; you would be able to exclude from income a portion of each payment you receive until you have received the full $3600 attributable to your annuity purchase.
While you can never do better financially by using this strategy rather than taking all of the money yourself and buying a commercial annuity, it will permit you to make a meaningful contribution to your favorite charity and still get an ongoing payment for the rest of your life. It is definitely worth considering, especially if you do not need the entire IRA distribution to make ends meet.
This Gate Closes December 31, 2007. IRA distributions that are made in taxable years beginning after December 31, 2005 and before January 1, 2008 can qualify as QCDs. Since most individual taxpayers are on a calendar year, QCDs must be made by December 31st of next year.
Interesting Questions that Await Clarification in
Regulations or Rulings.
(i) What kind of restrictions can be placed on a distribution of IRA funds; clearly they cannot rise to the level of a donor advised fund, but are program restrictions of any kind permissible?
(ii) It is not clear that the owner of an IRA can demand that the sponsor or custodian make a QCD to a particular charity, though it would be possible to direct a Trustee-to-Trustee transfer be made to a new IRA sponsor program if the current one refuses to pay the QCD.
(iii) If more than $100,000 is distributed to a qualifying charity in a lump sum, can the portion up to the limit be treated as a QCD, or must the entire distribution qualify? What about the second $60,000 distribution to qualifying charities in a single year?
(iv)Do IRA sponsors or administrators have any responsibility to determine that the distributee is in fact a charity?
(v) What will be the reporting requirements of IRA sponsors and administrators regarding the name and information of the person who directed the payment?
(vi) Would only the owner of an IRA or also anyone with check-writing authority on that account be able to designate a charitable distributee?
(vii) Can QCDs be made only in cash, or in securities?
(viii) Can QCDs be made from inherited IRAs?
The Future of this Provision. As the 3% haircut on deductions provides most of the impetus for this change but is in pretty constant flux (reduced by one-third in 2006-7, another one-third in 2008-9, eliminated in 2010 and reappears in 2011 – similar to the Federal Estate Tax), it will be interesting to see if this provision is extended and on what terms. Since it is likely to be revisited, this may also provide an opportunity to seek (i) extension to distributions in return for charitable gift annuities and distributions to charitable remainder trusts, as well as (ii) lowering the age of qualifying IRA owners that can direct QCDs to 59˝ years.
[1] This presentation is based upon my analysis of the legislation as informed by several excellent sources: Council on Foundations, IRA Charitable Rollover, www.cof.org; Marc Hoffman, The Pension Protection Act of 2006: A Guide to Charitable IRA Rollovers, Planned Giving Design Center www.pgdc.com (Posted August 14, 2006); Varly, Elizabeth, Letter, Dated August 28, 2006, to Dept. of the Treasury, Planned Giving Design Center (Posted September 6, 2006); and Joint Committee on Taxation Technical Explanation, http://www.pgdc.com/pdf/JCX-38-06.pdf. This article available on www.wjlaw.com/NotComm.html.
[2] It is unclear whether the IRA owner can direct a sponsor, custodian or
administrator to make such a distribution or merely “suggest it.” The fact that the “donor” must get
substantiation to back up the fact that there has been no quid pro quo for
the distribution (as least for transfers over $75), begs the question, who is
the donor, anyway?
[3]
Marc Hoffman, Editor-in-Chief of the