A Planning Plum for that Pesky IRA You Don’t Need Anyway – Part 2
Last week I discussed a charitable planning technique for 2012 that admittedly had limited application. Today, I want to discuss how the same technique impacts 2013 and why it may make sense for the right taxpayer who wishes to juice up his/her charitable contributions.
First, the “right” taxpayer – s/he must be over 70 ½ years old and be pretty comfortably set. It helps to be in the upper tax brackets, i.e., more than $250,000 in adjusted gross income (AGI) for single taxpayers and $300,000 for married taxpayers. Finally, it helps to have a sizeable traditional or Roth IRA that is not “needed” to live on and can be used to fund charitable contributions.
The technique is known as a “qualified charitable distribution” from an IRA. It enables the taxpayer to direct a distribution from his/her IRA to a public charity (no private foundations or donor advised funds for this technique) while including neither the distribution in income nor the charitable contribution in deductions. As a sweetener, the directed distribution can also count toward fulfilling the taxpayer’s annual required minimum distribution (RMD). This charitable planning tidbit was thrown in as an extender in the American Taxpayer Relief Act of 2012. It is a case of “go directly to the bottom line, do not include in income, do not include in deduction.” It’s not a new technique – in fact, it existed in temporary mode from 2006 to 2011 and now again in temporary mode for 2012 and 2013 – but has not always been very relevant. In 2013 it will have far more relevance when paired with an oldie but goody that is unfortunately returning from the dead – the so-called “Pease limitation.”
Now, the “Pease limitation” is a questionable legacy from the first Bush Administration (that is, George H.W. “Read My Lips, No New Taxes” Bush). It was authored by Congressman Don Pease, Democrat of Ohio. I don’t actually recall ever referring to it as the “Pease limitation” back in the day but suddenly, that is its name. Anyway, it is a limitation that reduces a taxpayer’s overall itemized deductions by 3% of excess adjusted gross income (AGI) realized over certain levels (for 2013, $250,000 for singles, and $300,000 for married filing jointly). Got that? Your income increases so they reduce your deductions – but in no event by more than 80% of the total deductions! How magnanimous! The “Pease limitation” enabled the government to bring smoke and mirrors to a new level by effectively increasing taxes without increasing tax rates (“read my lips….”). The limitation went away for a couple of years as part of the tax cuts of the second Bush Administration (George W. “Tax Cut” Bush) but came roaring back in 2013, albeit at higher income levels than before. Now I don’t know about you, and I certainly don’t know about Don Pease, but I wouldn’t want such a taxpayer-unfriendly device named after me – I mean, give me Bill Roth’s mighty “Roth IRA” any day over the weasly “Pease limitation.” But to each his own. Suffice it to say, the “Pease limitation” has always peased me off royally.
Now for the planning – Let’s see how a qualified charitable distribution from an IRA gets around Pease. Irving is a single taxpayer with $450,000 of AGI who fits the criteria outlined above. He wishes to give $100,000 from his IRA directly to a qualified charity. Absent the exclusion, a $100,000 distribution from his IRA would increase Irving’s AGI to $550,000 and he would then claim a corresponding itemized deduction for his charitable contribution. But his additional $100,000 of income would also produce an unfortunate additional Pease limitation of $3,000 (3% of the excess AGI over $250,000). So effectively, only $97,000 of his charitable contribution would be tax deductible. Put another way, the “Pease limitation” generates an additional $3,000 of taxable income to Irving. He may be withdrawing $100,000 and giving the whole thing to charity, but for his efforts his federal income tax will also increase by 39.6% of $3,000, or $1,188.
Having the IRA custodian pay the $100,000 directly from his IRA to the public charity eliminates this extra tax. This is not an issue if the taxpayer is otherwise subject to the alternative minimum tax (AMT) because the “Pease limitation” does not factor into the calculation of the AMT. However, using the qualified charitable distribution has another favorable impact regardless of the applicable tax (regular or AMT) – it keeps AGI lower by excluding the amount of the distribution, which effects items that are tied to AGI, like the deductions for medical expenses, casualty losses, and even charitable contributions.
If you fit the criteria outlined above you should seriously consider the qualified charitable distribution for 2013.
