Charitable IRA provision: Time is now

Once again, the qualified-charitable-distribution provision is set to expire at year-end. Not taking advantage of this provision could…

Once again, the qualified-charitable-distribution provision is set to expire at year-end. Not taking advantage of this provision could be costly for high earners due to the 2013 tax increases affecting these clients. In fact, not using the QCD provision could cost a client $10,000 or more in unnecessary taxes.

Example: The Grahams are a married couple who are each over 701/2 and have substantial individual retirement account balances. Before taking any IRA distributions for the year, the Grahams have $250,000 in adjusted gross income consisting of $50,000 in Social Security benefits and $200,000 in net investment income. The Grahams are charitably inclined and have decided to give $200,000 to charity this year, and plan to do so using their IRAs.

The Grahams essentially have two choices. The first option — and the far better one — is for them to take advantage of the QCD provision by having $100,000 sent from each of their IRAs directly to a qualifying charity. The second option is to take $200,000 out of their IRAs and write a check to the charity.

SAME LIABILITY

Assuming the Grahams' respective required minimum distributions are each $100,000 or less, their QCDs will completely satisfy their 2013 RMD requirements. The Grahams will not be able to take a charitable deduction, but their IRA distributions will not be added to their income. As a result, the Grahams' AGI will remain at $250,000. By using the QCD, the Grahams' tax liability will be exactly the same as it would have been had they not taken any IRA distributions at all.

If instead of using the QCD, the Grahams took the $200,000 out of their IRAs, they would add $200,000 in income to their AGI, bringing it up to $450,000. It would also add $200,000 in income to their modified AGI for purposes of the 3.8% health care surtax. Both of these would have a substantial effect on their 2013 tax liability.

For starters, the Grahams would go from being able to claim two full exemptions on their 2013 return to being unable to claim any personal exemptions at all, due to the personal-exemption phaseout. In 2013, the $3,900-per-person personal exemption that clients are generally allowed to claim for themselves, their spouse and their dependents begins to phase out for married couples filing joint returns when AGI exceeds $300,000. The phaseout is complete at $422,500. Thus the Grahams would pay tax on an additional $7,800 ($3,900 per exemption x 2) for 2013, which could, depending on other factors, increase their tax bill by roughly $2,500.

If the Grahams did not use the QCD, they also would not reap the full benefit of their $200,000 charitable contribution. Also coming back into the fold in 2013, after a three-year reprieve, is the 3% limitation on overall itemized deductions, also known as the Pease limit. For 2013, that kicks in at $300,000 for married couples filing a joint return.

As a result, the Grahams would be $150,000 above their applicable AGI limit and, assuming the $200,000 charitable contribution were their only deduction, they would be able to claim only $195,500 of deductions, and $4,500 ($150,000 excess income above AGI threshold x 3%) of deductions would be lost. They would likely owe somewhere around an additional $1,500 in tax.

(Charitable contributions are deducted after AGI is calculated and thus have no impact on that total.)

The loss of personal exemptions and a portion of itemized deductions is only the beginning, though. On top of that, by not using QCDs, the Grahams would find themselves subject to the 3.8% health care surtax assessed on the lesser of a client's net investment income or their MAGI above the applicable threshold. For married couples filing joint returns, that threshold is $250,000.

Had the Grahams used QCDs to fund their charitable desires, their MAGI would have been $250,000, so despite the fact that they have $200,000 in net investment income, none of it would be subject to the surtax. However, if the Grahams did not use QCDs, their MAGI would be $450,000, so their full $200,000 in net investment income would be subject to the surtax (they would be $200,000 over their threshold and would have $200,000 in net investment income), amounting to an additional $7,600 in tax.

With no difference in what the charity ultimately received, they would save more than $10,000 in taxes. Your clients could save even more. If qualifying clients want to donate, the QCD is almost always the best approach.

Take advantage now, before the tax break expires.

Ed Slott ([email protected]), a certified public accountant, created The IRA Leadership Program and Ed Slott's Elite IRA Advisor Group.