Qualified charitable distributions return

As expected, Congress has renewed the special tax break for charitable individual retirement account rollovers, known as qualified…

As expected, Congress has renewed the special tax break for charitable individual retirement account rollovers, known as qualified charitable distributions.

QCDs apply only to IRA owners and beneficiaries 701/2 or older who make a direct transfer to a qualifying charity from their IRA. The transfer can satisfy the annual required minimum distribution without that distribution being included in income.

QCDs are limited to $100,000 per year, per person.

The provision allowing QCDs expired after 2011. But the American Taxpayer Relief Act of 2012 retroactively reinstated QCDs for 2012 and keeps them through this year.

If Congress takes no action, they expire again at the end of this year.

The Taxpayer Relief Act includes two special rules that allow financial advisers’ clients to take advantage of QCDs for 2012 by taking one this month.

NO CLEAR ANSWER

As a result of Congress’ taking so long to address QCDs, a planning issue with no clear answer arose for some clients.

On one hand, if they took a distribution from their IRA and Congress later reinstated QCDs, it might not have qualified for the provision. On the other hand, if Congress took no action and they didn’t take a RMD, they could have faced a 50% penalty for their missed RMD.

Congress helped resolve any potential problems for clients who chose either of these actions by including two useful solutions in the law. One special rule allows a QCD to be taken this month and have it count for 2012.

Basically, this rule allows you to treat a QCD made this month as if it were taken on Dec. 31, 2012.

This special rule should be given strong consideration if your client didn’t take all or part of his or her RMD last year, as it will avoid the 50% penalty for not taking an RMD. Some clients waited until the last minute of last year to take their RMD, hoping that QCDs would be reinstated, only to discover that they missed the custodian’s cutoff date for processing RMDs.

This special rule can also be used to get around the $100,000 annual QCD limit for clients who want to use a larger portion of their IRA to tax efficiently donate to charity.

Consider this example. Mildred, 80, lives in New Jersey and has a $1 million traditional IRA.

She would like to use as much of her IRA as possible to donate to charities involved in helping Hurricane Sandy victims without paying any tax. Mildred can make a $100,000 QCD by Jan. 31 and elect to treat it as being for 2012 and then make another $100,000 QCD later in the year for 2013.

Both QCDs would be tax-free and wouldn’t increase her adjusted gross income for either last year or 2013, helping to prevent possible side effects such as the loss of itemized tax deductions, phaseout of personal exemptions or credits, additional portions of Social Security being taxable or even the imposition of the new 3.8% surtax on investment income. The QCDs also would satisfy her IRA RMDs for both years (given the facts, Mildred’s RMD would be less than $100,000).

SECOND RULE

The second special rule created by the law to address the issues created by its late passage allows clients who took a “regular” IRA distribution last month to treat that distribution as a QCD for 2012. To do so, clients must act quickly, as this is a limited-time offer that requires action by Jan. 31.

The rule allows some or all of an IRA distribution that was payable to the taxpayer last month to be treated as a tax-free QCD for 2012 if two conditions are met:

• After the December 2012 distribution, some or all the distributed amount is transferred in cash to a qualifying charity before Feb. 1.

• The transferred amount meets all the QCD rules except for the fact that the initial December 2012 IRA distribution wasn’t dir-ectly paid to the charity.

The result of this option is that a December 2012 IRA distribution that was previously going to be included in income can now be transformed into a tax-free QCD for last year as long as the amount is transferred to a charity by Jan. 31.

For charitably inclined clients 701/2 or older who took an IRA distribution in December, this option should be explored before the end of the month.

For IRA distributions done at any time last year that were made directly to charities in anticipation of the provision’s being extended, those distributions now qualify as a QCD and thus are tax-free.

Ed Slott (irahelp.com), a certified public accountant, created The IRA Leadership Program and Ed Slott’s Elite IRA Advisor Group.