The so-called extender legislation late in 2015 made permanent the provision allowing a retiree to move funds directly from an IRA to a charity without income recognition. The key feature is that these transfers count for the annual Required Minimum Distributions (RMD) that every IRA holder over age 70 1/2 must withdraw.
This special tax rule requires that the taxpayer must have attained age 70 1/2, and the transfer must be made directly from the IRA account to a qualified charity (other than a private foundation or donor-advised fund). These transfers are subject to a $100,000 annual limit per person. When done properly, there's no income from the IRA withdrawal, but no charitable deduction either. So why bother, given this technique appears to give the same result as drawing out taxable IRA income and issuing a tax deductible check to charity?
Removing some or all of the IRA RMD from income lowers the taxpayer's Adjusted Gross Income or AGI on page 1 of your 1040. For upper-income taxpayers (single filers above $260,000 and joint filers above roughly $310,000), personal exemptions and itemized deductions phase-out based on AGI. Generally, there will be a 2% to 3% rate savings for these filers on the RMD amount deflected to charity.
3.8% NET INVESTMENT INCOME TAX
The Affordable Care Act brought a new 3.8% tax on net investment income to the extent a single filer is over $200,000 or a joint filer over $250,000 in AGI. Upper income farm retirees with income from rent, as well as occasional capital gain land sales, face this 3.8% tax. Again, deflecting some or all of the RMD amount to charity lowers the AGI and decreases the 3.8% tax.
LOWER INCOME FILERS
Amazingly, the real money in this technique is with lower income retirees. Many are in that $25,000 to $60,000 income range in their 1040 where a portion of Social Security benefits are taxable. The tax law contains a complicated formula: As income increases above $25,000 single or $32,000 joint (counting AGI plus half of the Social Security benefits), there's a gradual phase-in of the taxable portion of the benefits, first at 50% and then up to 85%.
As an additional savings, many retirees aren't deducting charitable contributions because the standard deduction is greater. In one example of a widow with about $50,000 of income, by simply removing $5,000 of IRA income via a transfer to her church, federal taxes were cut by $1,700, a 34% return! The savings arose because of both a reduction in taxable Social Security and the standard deduction not changing when direct charitable contributions decreased. In another example of joint filers in the $60,000 income range, a $5,000 IRA transfer saved over $600.
The results vary significantly based on income levels, the RMD amount, and the portion that's transferred to charity. However, every retiree with RMD income and some charitable deductions should check this opportunity with their tax adviser.
EDITOR'S NOTE: Andy Biebl is a CPA and tax principal with the firm of CliftonLarsonAllen LLP in Minneapolis with more than 40 years' experience in ag taxation, including 30 years as a trainer for the American Institute of CPAs and other technical seminars. He writes a monthly column for our sister magazine, The Progressive Farmer. To pose questions for future tax columns, e-mail AskAndy@dtn.com.
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