Last chance for some clients to lower their 2012 tax bill

One of the more convoluted provisions to come out of the new American Taxpayer Relief Act is the one that extends tax-free treatment of IRA distributions to charities through 2013.

On the surface, it may look like a simple two-year extension of the popular tax break that expired at the end of 2011. The provision allows IRA owners who are 70 ½ or older to direct up to $100,000 of their annual required minimum distribution (RMD) to a charity and to exclude that contribution from their adjusted gross income (AGI).

But it’s the transition rule that has left some advisers scratching their heads. Although the law was not passed and signed until January, the tax-free provision applies retroactively to 2012, under certain conditions, and to 2013.

Many older clients tried to hold off taking their RMD as long as possible last year while they waited for Congress to act,” said Jim Holtzman, a financial adviser and CPA with Legend Financial Advisors in Pittsburgh. In the end, they elected to take their IRA distribution by December 31 rather than risk a 50% penalty if they failed to do so.

Now, they get a do-over. Anyone subject to RMD rules who took a distribution in December 2012 can contribute up to $100,000 of that distribution to a charity by Feb. 1, 2013, and exclude it from their income when they file their 2012 taxes.

Or, eligible IRA owners can take a distribution in January 2013 and direct their IRA trustee to contribute the amount directly to a charity by February 1 and exclude the contribution from their 2012 income.

“It’s one of the crazier things that Congress has done,” said Holtzman. “But for anyone who can take advantage of it, it makes sense.”

Because many older taxpayers no longer have mortgages, they often don’t have enough deductions to make itemizing worthwhile. Instead, they usually claim the standard deduction, including an additional amount for taxpayers 65 and older
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Normally, only taxpayers who itemize their deductions are permitted to write off charitable contributions. But the extension of the tax-free IRA distribution to charities provision allows retirees to contribute to charity and to exclude the donation from their income on their tax return.

Lowering their AGI, in turn, may make it easier for them to claim other deductions tied to income limits, such as medical expenses that can be deducted only to the extent that they exceed 7.5% of AGI. (The threshold for deducting medical expenses increases to 10% of AGI in 2013 for taxpayers younger than 65).

“It is a big deal for certain taxpayers who want to be charitable and who don’t need their IRA distribution,” said Mike Robbins, a CPA with Rehmann, a wealth advisory firm in the Midwest.

However, both Holtzman and Robbins agreed that wealthy clients may want to wait until later this year to direct an IRA distribution to charity in order to lower their AGI for 2013 when the new 3.8% Medicare surtax on net investment income kicks in. Although the surtax does not apply to IRA distributions, lowering the AGI could shield investment income from the extra tax.