President Obama has signed legislation extending a broad range of expired tax breaks for businesses and individuals through the end of 2014.
The so-called “tax extenders” bill passed earlier this month renews 55 tax breaks that ended in 2013. The bill covers items ranging from bonus depreciation on purchases of fixed assets to unreimbursed expenses for teachers who buy school supplies. The most important provision for wealthy individuals age 70-1/2 and above maintains their ability to make direct distributions to charities of up to $100,000 from their IRAs and have the amount excluded from taxable income.
“It’s a huge benefit,” says Catherine L. Schnaubelt, CPA, and senior vice president at Atlantic Trust in Houston. “The law allows you to take up to $100,000 and donate it directly to a charity out of your IRA so the charity gets the full $100,000. While you don’t get the charitable deduction on the other side, you don’t have to claim it as income and pay taxes on it.”
Those donations also count against an individual’s minimum distribution requirement, according to Schnaubelt, who works with 100 clients who have approximately $1.1 billion of assets. Internal Revenue Service regulations require individuals to begin taking minimum distributions from their IRAs at age 70-1/2 based on a formula that accounts for the size of the IRA, marital status and other factors. Distributions from traditional IRAs, which are funded with pre-tax dollars––as opposed to Roth IRAs, which are funded with after-tax dollars––are taxed as income. The provision applies to both traditional and Roth IRAs, though the tax advantages clearly benefit traditional IRA holders.
“Let’s say a wealthy individual who has income from several different sources is required to take a $75,000 distribution from his IRA. That income will probably be taxed at the highest rate of 43.4%,” Schnaubelt says. “If he then took the net of that and donated it to charity, that donation may only be around $40,000. By donating the $75,000 out of his IRA to a charity, the charity gets the full amount and the individual does not have to claim $75,000 of income and pay taxes on it.”
For those on the cusp of being on the lower 39% tax rate, the benefits may be more far-reaching, Schnaubelt notes. “If a $100,000 minimum distribution bumps them up into that 43.4% rate, it affects all their other income because the tax effect is larger than just on the $100,000. It’s a huge thing.”
The provision also is valuable as an estate-tax planning tool. When a wealthy individual with a traditional IRA dies, the IRA becomes part of the estate. “If the individual has a taxable estate it could be subject to a 40% estate tax, Schnaubelt says. “It’s also an asset that has never paid income tax, so when the heirs inherit, every dollar is automatically subject to income tax. It is a very tax-inefficient asset to pass on.
“From an estate-tax planning standpoint, you can use that IRA asset for charity,” she continues. “Then there is no estate tax or income tax paid on it and that leaves other, more tax-efficient assets to pass-on to your heirs.”
Act Fast, Act Smart
Individuals who wish to take advantage of the charitable donation provision this year must act quickly––and smartly.
Charitable donations must be made through the IRA custodian, and not by the individual, to qualify for the tax benefit. Individuals may not take a distribution from their IRAs and then write a personal check to a charity. Donations must be made before Dec. 31, 2014.
Whether to make the tax breaks will become permanent is a debate likely to be renewed next year with Republicans in control of both chambers of Congress.
