IRAs are often a great source of funds to provide a benefit to your favorite charity. However as with many provisions of the U.S. Code, you need to be aware of the tax traps if one is to maximize the benefits to the charity and other IRA beneficiaries.
Recent news articles have focused on whether certain expired tax provisions will be extended to the 2014 tax year. One of the possible extenders that expired in 2013 allows individuals an annual $100,000 exclusion from gross income for “qualified charitable distributions” (QCD) from an IRA. In other words, an individual can designate $100,000 of RMDs (required minimum distributions) from an IRA (Individual Retirement Account) and contribute that RMD to a charity. If this tax provision were extended to 2014, the individual taxpayer would report the RMD distribution on line 15a of Form 1040, but show a zero taxable amount on line 15b of Form 1040. Since the individual would not have any taxable income by designating the RMD as a QCD, there would be no charitable deduction allowed. What happens if an individual desires to make a QCD in 2014 and learns after the fact that this tax provision was not extended? The individual would report the RMD as usual on line 15a, but would show zero exclusion of line 15b. Thus the entire RMD would be included in the individual’s gross income. The taxpayer’s only tax benefit for making the charitable donation would then be reported on Schedule A as an itemized charitable deduction, subject to the normal charitable and Sch. A deduction limitations.
One of the benefits of some IRA inheritances is that the beneficiary is allowed to stretch out the IRA’s RMDs over the life expectancy of the beneficiary. One tax trap that is sometimes triggered is naming a charity to receive a percentage of your IRA. For example, you designate that your IRA will leave 95% of its value to your grandchild and the remaining 5% to your favorite charity. If the grandchild had been the sole beneficiary, the RMDs would have been made over the life expectancy of the grandchild per IRS tables. Since the RMDs are stretched over a long period of time, these are often referred to as “stretch IRAs”. One benefit of a stretch IRA is that the inherited IRA can grow to a significant value over the grandchild’s extended RMD life. Since a charity does not have a life expectancy under the Tax Code, this provision can eliminate the stretch for the remaining beneficiary (the grandchild in this example). To avoid this tax trap, a better strategy would have been to split the IRA into two separate IRAs, naming the grandchild the beneficiary of the larger IRA and the charity as the beneficiary of the smaller IRA.
If you are fortunate to have both non-qualified (taxable) assets and IRAs, your family beneficiaries would likely benefit by you bequeathing the taxable assets to them and the IRAs to the charity. Why? A family member of an IRA inheritance will be subject to RMD rules and will incur a tax liability upon the distribution of those funds. If taxable assets are inherited, there would be no income tax paid on the receipt of those funds.
When considering making charitable gifts, consider meeting with your financial advisor, estate planning attorney, and tax advisor to avoid these and other tax traps. We encourage our tax preparation clients to seek our tax planning advice before making any significant financial decision.
If you want to learn more about your personal tax situation and how experienced tax professionals can benefit you, we invite you to call 610-594-2601 today to make an appointment at our Exton PA CPA office to discuss your situation. You can also schedule a consultation at Click Here.