Posted November 1st, 2004

Planning Matters

Once again the charitable sector is aggressively lobbying for the passage of the CARE Act or other stand-alone legislation that would simplify and encourage gifts from individual retirement accounts (IRAs). This month’s “Planning Matters” is devoted to some common questions about gifts from retirement plans, including when charitable gifts from these assets can make sense today while awaiting passage of the CARE Act.

Question: Are we precluded from accepting or encouraging gifts from retirement plans until the passage of the CARE Act or other charitable legislation affecting IRAs?

Answer: Not necessarily. In most cases charitable gifts may be arranged from these plans in a fashion that will, in effect, result in much the same tax treatment as under the proposed law.

Question: Wouldn’t donors of IRA assets receive additional tax benefits under the CARE Act?

Answer: Not always. The various proposals basically make qualified charitable transfers “non-taxable” events, which, in effect, guarantees a “wash” for tax purposes that may already be possible under current law.

Question: What do you mean by a “wash” for tax purposes?

Answer: A “wash” occurs when there is a tax deduction that fully offsets a tax liability. For example, suppose I withdraw $10,000 from my IRA and give that money to charity. On one hand I have $10,000 of taxable income and on the other a $10,000 tax deduction, resulting in no additional tax liability—hence a “wash.”

Question: Does this mean that all donors can now give funds from IRAs on a tax-free basis?

Answer: No. Remember they generally must be over 591⁄2 (the CARE Act includes similar age limits) and gifts must be structured in such a way that they create a deduction that fully offsets tax liability. This means that gifts must be within the 50% of adjusted gross income limitation and that the partial reduction of itemized deductions for some high-income tax-payers must be considered.

Question: Can you give an example?

Answer: Suppose that you have a recently retired couple, both of whom are over the age of 591⁄2, with a $75,000 adjusted gross income. They would like to make an outright gift of $25,000. They have an IRA worth over $1 million. Under today’s law, they can withdraw $25,000 from their IRA and use those funds to make the gift, which is fully deductible up to 50% of their adjusted gross income. Note that the IRA withdrawal serves to increase their AGI to $100,000, so their gift could be even larger.

Question: What about the limit on itemized deductions for high-income persons?

Answer: Persons with taxable incomes above a certain level ($142,700 for joint filers in 2004) will find that their itemized deductions are reduced by 3% of the amount that their income exceeds the threshold amount. For instance, if a donor’s income were $100,000 over the threshold, his or her itemized deductions would be reduced by 3% of that amount, or $3,000. Practically speaking, this limitation rarely affects charitable gifts. The $25,000 gift described above would be unaffected.

Question: What about people with incomes far in excess of the threshold?

Answer: Take the case of a donor with $1 million in income over the threshold. He or she would find that itemized deductions for taxes, mortgage interest, and other expenses would be reduced by 3% of that amount, or $30,000, whether or not they made charitable gifts. If a taxpayer in this situation decided to make a gift from IRA assets, the gift would still result in a virtual wash for tax purposes. In this situation, a $100,000 IRA withdrawal followed by a charitable gift in the same amount increases adjusted gross income by $100,000, which would entail a reduction of the taxpayer’s itemized deductions by $3,000. The result is a 97% wash for tax purposes, with just $3,000 of the withdrawal amount subject to tax. In a 35% tax bracket, some $1,050 in tax would be due on the $100,000 withdrawal. Keep in mind also that many wealthy donors will have other itemized deductions, such as taxes and mortgage interest, that are “fixed” and would arguably absorb the statutory reduction amount whether or not a charitable gift was made.

Question: What about persons over 701⁄2 who are forced to take retirement plan withdrawals they do not need?

Answer: This could be an ideal situation for a charitable gift. If they itemize, charitable gifts of these funds and the resulting offsetting charitable deduction allow them to direct the full use of those funds to charitable purposes without any net additional tax.

Question: What if the donor is concerned about the size of the gift or bumping into the 50% AGI limitation?

Answer: This concern might be addressed by breaking the gift into installments. For example, assume a retired couple with a $100,000 AGI would like to make a $200,000 gift from an IRA with a balance of over $2 million. If they withdrew $200,000 to make the gift, they would not be able to fully deduct it. Their new AGI would be increased to $300,000, but their deduction would be limited to $150,000. However, if they broke the withdrawal and subsequent gift into two equal installments over two tax years, the gift would be fully deductible. This could be as simple as making one gift in December of 2004 and the other gift in January of 2005.

Question: I have a prospect for a life income gift. Do you have any suggestions?

Answer: The charitable deduction associated with a charitable remainder trust, pooled income fund, or charitable gift annuity funded with a retirement plan withdrawal will result in only a partially offset-ting deduction. As a result, the donor may want to use additional assets to increase the size of the split interest gift until an offset is achieved. Or a donor that is funding a life income gift with cash, stock, or other appropriate assets may choose to use that charitable deduction to shelter required withdrawals from his or her retirement plan. Under the CARE Act, no tax would be due on assets used to fund life income gifts, but it should be noted that the CARE Act would not allow income from trusts and annuities funded with IRA assets to be paid to those other than the taxpayer or a spouse, and all income received from gift annuities and charitable trusts would be subject to ordinary income taxes, so there may be future income tax advantages to funding such gifts with other assets.

Question: Can you summarize the issues associated with gifts from retirement plans today?

Answer: The best prospects for these gifts will be persons over 591⁄2 with significant retirement plan balances. Re-member that deductions are limited to 50% of AGI for gifts of cash, so consider the advantages of breaking the gift into installments where larger gifts are concerned. In most instances, the 3% limitation on itemized deductions for high-income taxpayers should not be a serious issue. Don’t forget to promote beneficiary designations as a way to keep these assets from ever being subject to an income or estate tax.

With trillions of dollars at stake, it may be unwise to wait for pending or proposed legislation to make gifts of retirement plan assets more attractive. Remember the CARE Act applies only to IRA assets and not to funds in 401(k) plans or other retirement planning options. In the final analysis, the CARE Act should result in additional gifts by removing certain disincentives and making it easier to plan gifts of IRA funds. But significant tax planning opportunities already exist under current law, and charities that fail to promote appropriate gifts of these assets may be missing an important “pocket” from which donors can make meaningful gifts today.

Editor’s note: Many of the concepts and scenarios discussed in this article are drawn from Sharpe seminar presentations and publications such as “Giving Through Retirement Plans.”

The publisher of Give & Take is not engaged in rendering legal or tax advisory service. For advice and assistance in specific cases, the services of your own counsel should be obtained. Articles in Give & Take may generally be reprinted for distribution to board members and staff of nonprofit institutions and other non-donor groups. Proper credit must be given. Call for details.

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