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Charitable Transfers Get Maximum Return on 'Minimum Distribution'

Many retired taxpayers who must take a Required Minimum Distributions from an IRA are not able to itemize, due to the additional standard deduction for age 65 or older and the fact that their mortgage is paid off; they therefore get no tax benefit from their charitable contributions. By using a direct transfer to the charity of their choice to satisfy their annual required minimum distribution they will be able to get the full tax benefit for their contribution, as well as possibly reducing their taxable Social Security.

What if there is a "tax basis" in Dave's IRA from nondeductible contributions and part of his RMD is tax-free? If he decides to transfer his entire $4,263 RMD to various charities during 2013 but the calculation from Form 8606 indicates only $3,950 of the distribution would have been taxable, Ely can claim the $313 "return of basis" as a charitable contribution on Schedule A.

Be advised that charitable distributions should be made only from a "traditional" IRA. Because qualified distributions from a Roth IRA are totally tax free to the owner as well as his or her beneficiaries, there is no tax benefit in a direct transfer of funds from a Roth IRA to a charity. In such a case it would be "more better" to take a distribution from the Roth and make a cash contribution to the charity. The Roth distribution is not included in taxable income, and the contribution can be claimed as a deduction on Schedule A.

Qualifying taxpayers may also want to consider making a direct transfer from a traditional IRA to a charity now, instead of having a cash bequest made from their estate. As beneficiaries will be taxed on monies received from an inherited traditional IRA, by making the contributions as a direct transfer now one will:

  • Reduce the tax cost to the beneficiaries of their inheritance.
  • Reduce the balance in the traditional IRA, which will in turn reduce subsequent taxable required minimum distributions.
  • Get the money to the charity sooner.
  • Enjoy the appreciation of the charity during one's lifetime.
  • See how the contribution is put to use.

This technique can also be used by higher-income taxpayers to reduce or eliminate the new 3.8% Medicare surtax. If a married couple has $175,000 of earned income and $75,000 of investment income this year and must take a $50,000 RMD from their IRA, $50,000 will be subject to the new surtax. But if that couple elects to distribute the $50,000 IRA RMD directly to a charity, no income will be subject to the Medicare surtax. The couple will save $1,900!

Because the extension for tax year 2012 was not extended until January, the Act permits two special options. You can choose to treat an IRA distribution received in December as a tax-free transfer to a charity and not reportable on your 2012 Form 1040, if the money is transferred to a charity before Feb. 1. Or you can treat distributions made from an IRA to a charity in January as being made in December, allowing up to $200,000 to be transferred during this calendar year.

By the way, the direct, tax-free transfer to a charity is not available from SEPs or Simple IRAs.

Robert Flach has more than 40 years of experience as a tax professional and also blogs as The Wandering Tax Pro.
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