Sec. 408(d)(8) permits “qualifying charitable distributions” from traditional IRA or Roth IRA accounts to be excluded from gross income. The provision first appeared in the Pension Protection Act, P.L. 109-280, in August 2006, as a temporary measure. In the intervening years it lapsed and was revived several times. The Protecting Americans From Tax Hikes (PATH) Act of 2015, P.L. 114-113, made it permanent. It is a powerful incentive to charitable giving, and through the use of life insurance, the ultimate amount the charity receives can be substantially increased.
What is a “qualifying charitable distribution”?
The requirements are relatively simple. The charitable distribution must be:
- From a traditional IRA or a Roth IRA;
- Direct from the IRA trustee to the charitable organization—with no intervening possession or ownership by the IRA owner;
- On or after the IRA owner has reached age 70½; and
- A contribution to an organization that would qualify as a charitable organization under Sec. 170(b(1)(a), other than a private foundation or donor advised fund.
Tax benefits of charitable IRA distributions
Charitable IRA distributions come with several tax benefits, some not readily apparent, that this article explores in part.
Avoiding the percentage limitation on charitable contributions: This is perhaps the most significant tax benefit of making a charitable IRA distribution instead of a direct contribution to a charity. Under the standard IRA distribution rules, if a donor takes $100,000 out of an IRA and gives it to a charity, the $100,000 first has to be included in gross income. Then the donor gets a charitable contribution itemized deduction. The possible problem is that the donor’s $100,000 contribution deduction will run into the 50%-of-adjusted-gross-income (AGI) limitation under Sec. 170(b)(1).
As a result, it is possible that the donor will not be able to deduct the full $100,000 in the year of contribution. That will force the donor to pay income tax on the difference between the $100,000 and the deductible amount. Carryover provisions allow the excess contributions to be carried forward for five years. But still the donor would have to pay more income tax (possibly a lot) than would otherwise be the case and take his or her chances of having enough taxable income to be able to recover the excess contribution in future years.
A Sec. 408(d)(8) charitable IRA distribution completely avoids that issue. By excluding the $100,000 from gross income, in effect the donor gets a $100,000 charitable contribution deduction—since the $100,000 isn’t included in income, it is, effectively, deducted.
Itemized deduction and personal exemption phase outs: For taxpayers with higher AGIs, Sec. 68 phases out itemized deductions as does Sec. 151 for personal exemptions. For 2016, the phaseout of itemized deductions and personal exemptions begins when taxpayers have AGI of $259,400 ($311,300 for joint filers or surviving spouses). Because the charitable IRA distribution isn’t included in gross income, it will not be included in AGI. Since it is not included in AGI, it avoids artificially inflating AGI and possibly triggering these phaseouts.
Use the standard deduction: Taxpayers who take the standard deduction do so because their itemized deductions aren’t large enough. Therefore, the standard deduction is more beneficial to them than itemizing. Because the charitable rollover completely avoids the donor’s tax return, the donor can effectively get both the standard deduction and the charitable contribution deduction.
Effect of AGI: Under Sec. 213(a), the medical expense itemized deduction has a 10%-of-AGI floor (through 2016, taxpayers 65 and over have a 7.5%-of-AGI floor on medical expenses), and most miscellaneous itemized deductions have a 2%-of-AGI floor. That is, only the amounts in excess of those percentage floors are deductible. By not being included in AGI, the charitable rollover does not increase the floor and thereby does not reduce the amounts otherwise deductible.
Less likely that Social Security will be taxable: An increase in an individual’s base amount (a type of modified AGI that includes half of the taxpayer’s Social Security benefits under Sec. 86) may make more of the individual’s Social Security benefit subject to income tax. By not being included in AGI, the charitable rollover will not be included in the base amount, which would otherwise result in an increase in the amount of Social Security income subject to income tax.
State income taxes: Some states do not allow deductions for charitable contributions. In those states, the charitable rollover provisions avoid a possible increase in the donor’s state income tax.
Required minimum distribution (RMD): The charitable rollover is included in determining the amount of the RMD. Therefore, if the RMD was $60,000, a $100,000 distribution would satisfy the requirement for that year. The taxpayer would not be required to take the $60,000 into income. Unfortunately, the excess $40,000 cannot be carried over to later years to help satisfy those years’ RMD requirements.
Spouses: The provision applies to each individual’s IRAs. In many marriages, both spouses will have IRAs. Therefore, it’s possible that the spouses could team up, each rolling over $100,000 for a $200,000 rollover contribution to a single qualified charity.
Annual limit: The $100,000 is an annual limit. Therefore, a donor could do it every year.
To reiterate, the charitable IRA distribution is no longer a temporary, expiring measure but now allows for longer-term charitable distribution arrangements and plans.
Increasing the benefit with life insurance
If the charity and the donor cooperate, the benefit of the distribution can be increased by using life insurance. This is accomplished by having the charity use the distribution to purchase a single premium life insurance policy on the donor’s life. This will increase the amount the charity will ultimately receive as a result of the distribution.
Consider the following examples:
- 71-year-old male, standard nontobacco life insurance policy. A $100,000 single premium will generate a $152,360 policy benefit.
- 71-year-old female, standard nontobacco life insurance policy. A $100,000 single premium will generate a $179,990 policy benefit.
- 71-year-old male and female, standard nontobacco, survivor policy. One $200,000 premium, $100,000 from each person’s IRA, will generate a $378,760 policy benefit.
David Smucker, CPA, MSM, CLU, ChFC, is Advanced Consulting Group director with Nationwide Insurance in Columbus, Ohio.