Richard Fox & Why Taxpayers Should Proceed with Caution in Light of IRA Charitable Rollover Provision Having Expired on December 31, 2013

Richard Fox & Why Taxpayers Should Proceed with Caution in Light of IRA Charitable Rollover Provision Having Expired on December 31, 2013

Article posted in Outright Gift on 7 March 2014| comments
audience: National Publication, Richard L. Fox, Esq. | last updated: 7 March 2014
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Summary

While the IRA Charitable rollover has survived time and time again since 2006, in this article Richard Fox explains why donors and their advisors need to beware and proceed with caution.

Reproduced Courtesy of Leimberg Information Services, Inc. (LISI) at http://www.LeimbergServices.com

Written by Richard L. Fox, Esq.

EXECUTIVE SUMMARY:

The IRA charitable rollover provision brought about by the Pension Protection Act of 2006, contained in IRC § 408(d)(8), provides an annual exclusion from gross income up to $100,000 for “qualified charitable distributions” from an IRA, thereby removing the multitude of potential negative tax drawbacks traditionally associated with funding charitable contributions with IRA withdrawals, to the extent of $100,000 per year. Although the IRA charitable rollover provision was enacted as a temporary charitable giving measure, originally set to expire on December 31, 2007, each time it has been set to expire, Congress has extended the provision, although it has never been made permanent.

In recent years, however, the provision has been extended retroactively after it had already expired, leaving taxpayers and charities alike in the dark during the course of the taxable year as to whether the IRA charitable rollover provision would be ultimately available for that year. For example, the last time the IRA charitable rollover provision was set to expire was on December 31, 2011, but under the American Taxpayer Relief Act of 2012 ("ATRA"), which President Obama didn’t sign into law until January 2, 2013, the IRA charitable rollover provision was extended retroactively back to January 1, 2012 and through to December 31, 2013.  The provision has not yet been extended for the year 2014 and, therefore, is currently not available, although, given the track record of Congress, it is still quite likely that this highly favorable and popular charitable giving provision will be retroactively reinstated to January 1, 2014.

Based on what transpired when the IRA charitable rollover provision has previously expired and was later retroactively reinstated, taxpayers who would otherwise distribute their 2014 required minimum distributions (“RMDs”) to charity if the IRA charitable rollover provision was in effect should not take such distributions personally if they intend to have the charitable rollover provision applied if it is ultimately reinstated for the tax year 2014.  At this point, for those who would otherwise consider utilizing the IRA charitable rollover provision if it is ultimately reinstated during 2014, the most prudent course of action is to simply defer action until the law in this area becomes clear over the remainder of 2014 if and when Congress acts.  But, if a taxpayer is intent on having the RMD go to charity before the tax issue is clarified (because, no matter what, cash in the amount up to or greater than the RMD would otherwise be paid by the taxpayer to charity during the year), the RMD should be made directly to charity so as to fall within the IRA charitable rollover provision should the provision be reinstated retroactive to January 1, 2014.

Where a taxpayer’s RMD is less than $100,000, until the IRA charitable rollover provision is clarified for 2014, it is not prudent from a tax standpoint to distribute funds from an IRA to charity in excess of the RMD amount, as doing so would subject such excess amount to income tax if the IRA charitable rollover is not reinstated for 2014 which could otherwise be avoided by using other assets to fund charitable giving. In any event, if the IRA charitable rollover provision is ultimately not reinstated for 2014, any distribution from an IRA directly to a charity would be treated for tax purposes as being directly received by the taxpayer (and treated as income) and then contributed by the taxpayer to the charity (eligible for a charitable income tax deduction, subject to applicable limitations), the same result as where the distribution is actually made to the taxpayer and then actually contributed to the charity by the taxpayer.

FACTS:

Background on IRA Charitable Rollover Provision for Donors Having Reached Age 70 1/2

The IRA charitable rollover provision brought about by the Pension Protection Act of 2006, contained in IRC § 408(d)(8), provides an annual exclusion from gross income up to $100,000 for “qualified charitable distributions” from an IRA, thereby removing the multitude of potential negative tax drawbacks traditionally associated with funding charitable contributions with IRA withdrawals.  Thus, individuals qualifying for IRA charitable rollover treatment (who must have reached age 70 1/2) wishing to make distributions from an IRA to charity can do so, to the extent of $100,000 per year without the risk of any additional tax burden.  Of course, because it is excluded from gross income, a qualified charitable distribution from an IRA does not qualify for a charitable income tax deduction; otherwise, there would be the double benefit of income exclusion and a charitable contribution deduction.

A qualified charitable distribution is taken into account for purposes of the annual minimum required distribution requirement to the same extent the distribution would have been taken into account under such rules had the distribution been made to the account holder. As a result, a donor can distribute his entire annual minimum required distribution to charity without any of such amount being subject to tax. Where a distribution to charity does not qualify as a qualified charitable distribution, however, the amount distributed is taxed as if it were received by the account holder and then contributed to the charity under rules that apply in such a case without regard to the IRA charitable rollover provision under IRC § 408(d)(8).

Statutory Requirements for a Qualified Charitable Distribution from an IRA

There are six requirements for an IRA distribution to qualify as a qualified charitable distribution under the IRA charitable rollover provision, as set forth below.

1. IRA Accounts Only

The distribution must be made from an IRA. For this purpose, Simplified Employee Plans (SEPs) and Savings Incentive Match Plans for Employees (SIMPLE plans), which are basically IRAs that receive employer contributions, as well as IRC §§ 403(b) and 401(k) plans, profit-sharing plans, and pension plans, do not qualify under the IRA charitable rollover provision. Many individuals over seventy and one-half years old have large IRA balances attributable to rollovers from retirement accounts maintained at their former employers, which can be used to make distributions to charity. Where applicable, individuals over seventy and one-half years old who do not have IRAs can take advantage of the IRA charitable rollover provision by, for example, transferring funds from an existing IRC § 401(k) plan into a newly established IRA. Generally, the exclusion for qualified charitable distributions is available for distributions from any type of IRA (including a Roth IRA described in IRC § 408A and a deemed IRA described in IRC § 408(q)) that is neither an ongoing SEP IRA described in IRC § 408(k) nor an ongoing SIMPLE IRA described in IRC § 408(p). For this purpose, a SEP IRA or a SIMPLE IRA is treated as ongoing if it is maintained under an employer arrangement under which an employer contribution is made for the plan year ending with or within the IRA owner's taxable year in which the charitable contributions would be made.

2. Eligible Recipients

The recipient organization must be described in IRC § 170(b)(1)(A), which generally includes organizations commonly referred to as “public charities,” such as churches, hospitals, museums, and educational organizations. Donor-advised funds operated by public charities, and supporting organizations, while described in IRC § 170(b)(1)(A), are specifically excluded as eligible recipients of IRA charitable rollover distributions, such that distributions from IRAs to such entities, including, for example, a donor-advised fund sponsored by a community foundation or a hospital foundation formed as a supporting organization, do not constitute qualified charitable distributions. Also excluded are split-interest trusts, such as charitable remainder and lead trusts, and private nonoperating foundations, as such entities are not described in IRC § 170(b)(1)(A).

3. IRA Account Owner Must Be at Least Age 70 ½

The distribution must be made on or after the date that the IRA account holder attains age 70 ½.  Similarly, the exclusion from gross income for qualified charitable distributions is available for distributions from an IRA maintained for the benefit of a beneficiary after the death of the IRA owner if the beneficiary has attained age 70 1/2 before the distribution is made.

4. Distributions Must Be Made Directly to Charity

The distribution from the IRA to the charity must be made “directly by the trustee,” such that the distribution must be made payable directly from the IRA account to the charity. If a check is made payable to the IRA account owner and then endorsed over to the charity, it will not qualify. Where, however, a check from an IRA is made payable to a qualified charitable organization and delivered by the IRA owner to the charitable organization, the payment to the charitable organization will be considered a direct payment by the IRA trustee to the charitable organization.

5. The Distribution to Charity Must Otherwise Be Fully Deductible As Charitable Contributions

A distribution to a charity will only qualify as a qualified charitable distribution if the “entire distribution would be allowable under section 170” as a charitable deduction. Thus, any quid pro quo benefit received by the account holder in return for the distribution, such as the FMV of a dinner or other benefit that is not disregarded under IRC § 170, disqualifies the entire distribution, not just the benefit portion, from IRA charitable rollover treatment.

The requirement that the entire distribution be allowable as a charitable deduction also prevents the funding of a pooled income fund or a charitable gift annuity from an IRA account from being considered a qualified charitable distribution, notwithstanding that the charity receiving the distribution is a public charity under IRC § 170(b)(1)(A). Further, under IRC § 170(f)(8), no charitable deduction is allowed for any contribution of $250 or more, unless the donor obtains a contemporaneous written acknowledgement, which must disclose the value of any goods or services provided by the charity in return for the contribution. Thus, to constitute a qualified charitable distribution, the donor must obtain a written acknowledgement indicating that no goods or services were received in return for the contribution.

When making a distribution from an IRA for which charitable rollover treatment is sought, donors will be best served by first advising the charity that: (1) a distribution will be made from the donor's IRA account to the charity, which is intended to constitute a “qualified charitable distribution” under IRC § 408(d); (2) no goods, services, or benefits of any kind are to be provided by the charity to the donor or any other party in consideration for the distribution; and (3) upon its receipt of the distribution, the charity must provide an acknowledgement to the donor, acknowledging the amount of the distribution and that no goods, services, or benefits of any kind were or will be provided to the donor or any other party in consideration for the distribution.

6. Distribution Must Otherwise Be Included in Gross Income

A distribution to charity from an IRA will only qualify as a qualified charitable distribution to the extent that the distribution would have otherwise been included in the account owner's gross income if such distribution had been withdrawn. Thus, only the taxable portion of any IRA distribution can qualify as a qualified charitable distribution. Of course, where a nontaxable distribution is made to a charity from an IRA, the account holder would not only be subject to tax on the distribution (as such amount is not included in gross income), but would also be entitled to a charitable income tax deduction under IRC § 170(b).

This would be the case, for example, for a Roth IRA, where a distribution that would otherwise not be taxable, as is generally the case, is distributed directly to charity. Where, however, a distribution from a Roth IRA would be taxable because it is made within the five-taxable-year period, the distribution can, in such a case, constitute a qualified charitable distribution provided all other requirements for such treatment are met, including the donor attaining age 70 1/2 . Under a special and favorable rule under the charitable rollover provision, distributions from an IRA to charity are deemed to come first from the taxable portion of the IRA account, thereby leaving the maximum amount of tax-free dollars behind.

Example:  Blake, who is over seventy and one-half years old, has an IRA with a balance of $100,000, consisting solely of deductible contributions and earnings. The entire IRA balance is distributed directly to an organization described in IRC § 170(b)(1)(A) that is not a donor-advised fund or a supporting organization, for which Blake receives no benefit in return. But for the IRA charitable rollover provision, the entire distribution of $100,000 would be includable in Blake's gross income. Accordingly, under the IRA charitable rollover provision, the entire distribution of $100,000 is a qualified charitable distribution. No amount is included in Blake's gross income as a result of the distribution and the distribution is not taken into account in determining the amount of Blake's charitable deduction for the year.

Example: Jeffrey, who is over seventy and one-half years old, has an IRA with a balance of $100,000, consisting of $20,000 of nondeductible contributions and $80,000 of deductible contributions and earnings. In a distribution to an organization described in IRC §170(b)(1)(A) that is not a donor-advised fund or supporting organization, $80,000 is directly distributed from the IRA, for which Jeffrey receives no benefit. But for the IRA charitable rollover provision, a portion of the distribution from the IRA would be treated as a nontaxable return of nondeductible contributions. The nontaxable portion of the distribution would be $16,000, determined by multiplying the amount of the distribution ($80,000) by the ratio of the nondeductible contributions to the account balance ($20,000/$100,000). Accordingly, under pre-IRA charitable rollover law, $64,000 of the distribution ($80,000 minus $16,000) would be includable in Jeffrey's income. Under the IRA charitable rollover provision, notwithstanding the pre-IRA charitable rollover tax treatment of IRA distributions, the distribution is treated as consisting of income first, up to the total amount that would be includable in gross income (but for the IRA charitable rollover provision) if all amounts were distributed from the IRA. The total amount that would be includable in income if all amounts were distributed from the IRA is $80,000. Accordingly, under the IRA charitable rollover provision, the entire $80,000 distributed to the charitable organization is treated as includable in income and is a qualified charitable distribution. No amount is included in Jeffrey's income as a result of the distribution and the distribution is not taken into account in determining the amount of Jeffrey's charitable deduction for the year. In addition, the $20,000 of the amount remaining in the IRA is treated as Jeffrey's nondeductible contributions.

Extension of IRA Charitable Rollover Provision When It Expired on December 31, 2009 and Was Retroactively Reinstated on December 17, 2010

The IRA charitable rollover provision was brought about by the Pension Protection Act of 2006 (PL 109-280) as a temporary measure and was set to expire on December 31, 2007.  Over the years, however, legislation has been enacted to extend this temporary measure, but it has never been made permanent. 

The first time the provision expired, i.e., on December 31, 2007, it was extended until December 31, 2009 under HR 1424 (PL 110-343), signed by President Bush on October 3, 2008.  In 2010, the IRA charitable rollover provision, which had expired on December 31, 2009, was reinstated (and signed into law by President Obama) on December 17, 2010, by the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 (HR 4853, PL 111-312). The legislation reinstated the IRA charitable rollover for two years through 2011, retroactive to January 2010.

Because the legislation was enacted virtually at the end of 2010, Congress allowed individuals who chose to make a qualified charitable distribution from their IRA for the taxable year 2010 any time during 2010 or January of 2011. Congress determined that the time necessary to make these transfers for 2010 should be extended for one additional month for the required 2010 distributions. Thus, an otherwise eligible distribution made at any time during 2010 or through January 2011 could be treated as a qualified IRA charitable rollover for the year 2010. Those taxpayers who had not taken their required minimum distributions for 2010 were allowed to have charitable rollovers made through January 2011 to be treated as if made in 2010.

One question that arose as a result of the extension of the IRA charitable rollover provision in 2010 was whether those individuals who had already taken their 2010 required minimum distribution amount, who would otherwise have given such distribution directly to charity as an IRA charitable rollover, could return their 2010 payouts to the IRA in order to then make direct charitable distributions from the IRA by January 31, 2011. According to a January 5, 2011 statement by the IRS, and to the upset of donors and charities alike, the answer was no.

The IRS statement clarified that taxpayers were not allowed to return any required minimum distributions they took in 2010 in order to make charitable IRA distributions for 2010. Many taxpayers were angered, saying it took lawmakers too long to extend the provisions. After waiting a year, many simply took their RMDs or made donations from taxable sources. After the extension was ultimately permitted, many felt they should have been able to roll back into an IRA the payouts they took under the assumption the extension would not occur. However, the IRS responded to this claim by saying that it did not have the authority to allow taxpayers to roll back their payouts into the IRA and then make the charitable donation. 

Extension of IRA Charitable Rollover Provision When It Expired on December 31, 2011 and Was Retroactively Reinstated on January 2, 2013

Under the American Taxpayer Relief Act of 2012 ("ATRA"), PL 112-240, which President Obama signed into law on January 2, 2013, the IRA charitable rollover provision, which had expired on December 31, 2011, was extended retroactively to January 1, 2012 and runs through the end of 2013.  Under ATRA, individuals having made an otherwise qualified IRA charitable rollover at any time during the taxable year 2012 were able to obtain the benefits of the IRA charitable rollover provision for that year, as the IRA charitable rollover provision was considered to have been in effect for the entire 2012 taxable year.

Many individuals, in anticipation of the IRA charitable rollover being reinstated retroactively (or based upon the mere possibility of its retroactive reinstatement) made direct distributions from their IRAs to charity during 2012 and, therefore, were able to obtain the benefits of the IRA charitable rollover provision for that year.  Because the legislation wasn’t enacted until January 2, 2013, Congress included two special transitional relief provisions to allow certain payments to charity made in January 2013 to count as being made in 2012, as described below.

Special Election for December 2012 IRA Distributions Contributed to Eligible Charity in January 2013

Under a special rule, for purposes of both (a) the tax-free qualified charitable distribution rules, and (2) the RMD rules as they apply to IRAs, any portion of an IRA distribution made to a taxpayer during December 2012 (i.e., after November 30, 2012, and before January 1, 2013) may be treated as a qualified charitable distribution if the IRA owner so elects at such time and in such manner as IRS will prescribe, to the extent that the portion is:

(i) transferred in cash after the distribution to an eligible charity before February 1, 2013; and

(ii) the distribution would otherwise satisfy the tax-free qualified charitable distribution rules, but for the fact that the distribution was not transferred directly from the IRA to an eligible charity.

This special election for December 2012 distributions provided a limited exception to the general rule that charitable transfers must be made by the IRA trustee directly to an eligible charity.

Example: Peter is an individual who is over age 701/2, and the owner of a traditional IRA. On Dec. 12, 2012, Peter received a $75,000 distribution from the IRA in satisfaction of his RMD for 2012.  Under the special rule for December 2012 distributions, Peter can elect to transfer to an eligible charity any amount of cash up to $75,000 (the amount of his 2012 RMD), and the amount transferred will be treated as a tax-free qualified charitable distribution, as long as Peter makes the charitable transfer no later than January 31, 2013. Peter will still be considered to have satisfied his 2012 RMD regardless of the amount of the charitable transfer.

As indicated above, this special election only applied to distributions from an IRA received during the month of December 2012. Distributions received in 2012, but prior to December 1, 2012, were not eligible for this special relief. The transitional relief under this provision, albeit only including distributions received in December 2012, was still better than the extension legislation under Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 (retroactively reinstating the IRA charitable rollover provision to January 1, 2010), which (as discussed above) did not allow any distributions received in 2010 (even in December 2010) to qualify for IRA charitable rollover treatment under any circumstances.  Under this special relief provision, unlike the rules otherwise applicable to IRA charitable rollovers, there was not a direct transfer from the IRA to charity, but rather from the participant to the charity.

Special Election for January 2013 IRA Distributions to Charity to Be Treated as Made in 2012

Under another special rule, for purposes of both (1) the tax-free qualified charitable distribution rules, and (2) the RMD rules as they apply to IRAs, any qualified charitable distribution made after December 31, 2012 and before February 1, 2013 (i.e., during January 2013), was deemed to have been made on December 31, 2012, if the IRA owner so elected.  Thus, at the taxpayer's election, a qualified charitable distribution made in January 2013 was permitted to be treated as made in 2012, and thus permitted to (a) count against the 2012 $100,000 limitation on the exclusion, and (b) be used to satisfy the taxpayer's RMD for 2012.

For purposes of the special election for January 2013 distributions, the IRA distribution must have been made by the IRA trustee directly to the eligible charity, unlike the exception to the direct transfer rule provided under the special election for December 2012 distributions discussed above.  A qualified charitable distribution made in January 2013 that was treated as a 2012 distribution satisfied the IRA owner’s undistributed 2012 required minimum distribution if the amount of the qualified charitable distribution equaled or exceeded the 2012 required minimum distribution.  However, no part of such a distribution could be used to satisfy the 2013 required minimum distribution, even if the 2012 required minimum distribution had already been made. 

Note: There was nothing under the two ATRA transitional relief provisions that prevents both of these provisions from being applied for the taxable year 2012.  The two transitional relief provisions could not, however, be combined so as to exceed the maximum tax-free distribution available under the IRA charitable rollover provision of $100,000 per year per taxpayer.

COMMENT:

Based on what transpired when the IRA charitable rollover provision has previously expired and was later retroactively reinstated, taxpayers who would otherwise distribute their 2014 required minimum distributions (“RMDs”) to charity if the IRA charitable rollover provision was in effect should not take such distributions personally if they intend to have the charitable rollover provision applied if it is ultimately reinstated for the tax year 2014.  At this point, for those who would otherwise consider utilizing the IRA charitable rollover provision if it is ultimately reinstated during 2014, the most prudent course of action is to simply defer action until the law in this area becomes clear over the remainder of 2014 if and when Congress acts. 

But, if a taxpayer is intent on having the RMD go to charity before the tax issue is clarified (because, no matter what, cash in the amount up to or greater than the RMD would otherwise be paid by the taxpayer to charity during the year), the RMD should be made directly to charity so as to fall within the IRA charitable rollover provision should the provision be reinstated retroactive to January 1, 2014. Where a taxpayer’s RMD is less than $100,000, until the IRA charitable rollover provision is clarified for 2014, it is not prudent from a tax standpoint to distribute funds from an IRA to charity in excess of the RMD amount, as doing so would subject such excess amount to income tax if the IRA charitable rollover is not reinstated for 2014 which could otherwise be avoided by using other assets to fund charitable giving.

In any event, if the IRA charitable rollover provision is ultimately not reinstated for 2014, any distribution from an IRA directly to a charity would be treated for tax purposes as being directly received by the taxpayer (and treated as income) and then contributed by the taxpayer to the charity (eligible for a charitable income tax deduction, subject to applicable limitations), the same result as where the distribution is actually made to the taxpayer and then actually contributed to the charity by the taxpayer.

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