KETRA Planning: IRA Withdrawal or LTCG Stock Sale -- Which is Better?

KETRA Planning: IRA Withdrawal or LTCG Stock Sale -- Which is Better?

Article posted in Retirement Plans on 10 October 2005| 1 comments
audience: National Publication | last updated: 18 May 2011
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Summary

Following publication of our follow-up article by Chris Hoyt on indirect IRA rollovers last week, PGDC member Bruce Kinsella posted the following comment: "Could you please illustrate an example of a donor cashing in stock, paying the long term gains, and gifting the cash?" That's a great question because if a donor would consider liquidating an ordinary income asset (such as an IRA) with an offsetting charitable deduction, why shouldn't they also consider doing the same with long-term capital gain assets?

by Marc D. Hoffman
Special thanks to Laura H. Peebles for her assistance in developing this article.

For background, readers can refer to these two previous articles:


In response to Mr. Kinsella's request, we could give a numerical example; however, it would be only one example that applies to only one set of facts and, therefore, wouldn't be usable in a meaningful way to assist in planning for a particular client.

As an alternative, we decided to discuss some of the issues and landmines to help planners arrive at the "best" answer.

1. The basis of the stock.

Most IRAs have a zero basis. Therefore, in most cases, participants will recognize a dollar of income for every dollar they withdraw. An exception exists for people that have made nondeductible contributions to their IRAs (which has been available since 1981) thereby increasing their basis proportionately. Thus far, most discussions have ignored this fact, but planners should consider it.

With respect to stock (or any other capital asset), the higher the seller's basis, the less the tax impact of the sale. Conversely, the closer to zero the basis, the more "extra gain" the sale incurs as compared to the alternative of making an outright (presale) donation that avoids gain altogether.

2. What other income and deductions are on the taxpayer's return?

In the case of the IRA, it's clear that withdrawals come in as highest-taxed income, and that the charitable contribution will be deducted against the highest-taxed income first.

Conversely, if the donor has a net long-term capital gain from a stock sale, the charitable contribution may be used to offset against other income first -- or maybe not. The taxpayer's itemized deductions would offset the highest-taxed income first, so you could have a situation where there's nothing on the return except income taxable at the 15% rate, offset by the charitable deduction being used at a 15% federal tax benefit. If the taxpayer would then have higher-taxed income in 2006, perhaps he is not maximizing the deduction's value. Arriving at a good answer requires multiyear projections and assumptions.

3. What other charitable contributions are being made, or have been made, in current and prior years?

If a 30% of AGI deduction of LTCG stock could be used in 2005 and used up in 2006, is it worth picking up the additional taxable gains in 2005 just to get to more than 50% of AGI for a cash gift in the current year? What assumptions do we make for present-valuing the 2006 (and future year's) potential tax benefit?

4. Are there other available assets to donate?

Is the decision a tradeoff between making a cash gift from existing available cash or selling stock and donating the proceeds? Or is it a decision of donating appreciated stock or the sales proceeds from that stock?

Pre-KETRA wisdom dictates that donors contribute their most highly appreciated stock and use cash they otherwise would have donated to repurchase new stock, thereby effectively stepping up their cost basis.

Because other charitable deductions (i.e., current year pre-KETRA window contributions and carryovers of excess contributions from prior years) are considered before the additional qualified KETRA contributions, donors might consider donating stock to the extent of their 30% limitation and then selling additional stock and donating the cash proceeds with an additional offsetting deduction.

Note: For further reading, refer to the examples in the section 301 of the JCT's Technical Explanation of KETRA.

5. Don't forget about capital loss carryovers.

If the donor is sitting on a capital loss carryover (too many tech stocks perhaps?) and has other unrealized capital gains, the scale might tip back in favor of the "sell and donate cash" concept. The reason for this is their effective rate on the gain would be reduced (possibly down to zero), but the cash would be subject to at least the 50% limit, if not the 100% KETRA limit.

6. To a lesser extent, assumptions that are included in the IRA models come into play.

Finally, what impact will the additional AGI caused by a stock sale scenario have on Schedule A items, and in what state does the donor live? Obviously, a "gross income" state would be an adverse factor, as would one that has its own charitable limitations that do not follow the Katrina bill. That alone could add almost ten percentage points to the tax bill if the donor lives in CA or NY and those states don't follow the Katrina bill's revised limits.

Conclusion

So, does selling stock or other capital assets, incurring gain, and giving cash to take advantage of the additional KETRA limits make sense? With the right fact pattern, it might. However, it might make even more sense to donate stock or other capital assets before selling them (an option that is unavailable with the indirect IRA rollover), avoid the gain on sale, claim a regular 30% (or for higher basis assets make the 50% special election), and carry any excess deductions over into future tax years.

The more we think about KETRA, the more we realize we need to think about it. "Ladies and Gentlemen: Start your computers!"

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Comments

KETRA and cash gifts after sale of stock

Nothing in life is simple, is it? Thanks, Mark and Laura, for a very clear demonstration of the complexities hiding behind the "sound bites". Those of us who are charity fundraisers and who do not daily wade through the swamps of the Internal Revenue Code should take special note. We have the obligation to present the opportunities associated with KETRA with caution, fully disclosing the donor's need to have full and adequate advice from the accountants who deal with contribution limitations, state AMT, and other tax esoterica on a daily basis.

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