The Katrina Relief Bill and Indirect" IRA Rollovers"

The Katrina Relief Bill and Indirect" IRA Rollovers"

Article posted in Retirement Plans on 26 September 2005| 4 comments
audience: Partnership for Philanthropic Planning, National Publication | last updated: 18 May 2011


Those following the Katrina Emergency Tax Relief Act of 2005 were disappointed to learn that a provision that would have allowed direct tax-free rollovers of IRA assets to charity failed to make it into the final bill. However, the planned giving community has been abuzz over the past few days discussing other bill provisions that may facilitate the next best thing -- the "indirect" IRA rollover. Is this a viable plan? It depends.

by Marc D. Hoffman

Those following the Katrina Emergency Tax Relief Act of 2005 were disappointed to learn that a provision that would have allowed direct tax-free rollovers of IRA assets to charity failed to make it into the final bill. However, the planned giving community has been abuzz over the past few days discussing other bill provisions that may facilitate the next best thing -- the "indirect" IRA rollover.

The concept is the same as under current law: Make a withdrawal from your IRA, donate the cash to charity, and claim a charitable contribution deduction. Under current law, however, such things as the percentage deduction limitations, itemized deduction reduction rules, and state income tax considerations create potential tax drag that can limit the amount of the gift and/or generate tax.

Is the indirect IRA rollover plan viable? It depends.

Following are the relevant component parts of the Katrina bill and their effect on gifts from IRAs:

Temporary Suspension of Limitations on Cash Gifts

Current Law: Under current law, donors can deduct up to 50% of their "contribution base" for cash contributions to public charities. (The term "contribution base" is the donor's adjusted gross income in the year of contribution without regard to a net operating loss that is generated in a subsequent tax year and then carried back, via an amended tax return, into the contribution year.) Amounts that exceed the 50% limit can be carried forward and subject to the same limitation up to five succeeding tax years.

New Law: Section 301 of the bill temporarily suspends the 50% limitation for "qualifying contributions" to the extent such gifts exceed the donor's "other" charitable contributions.

A qualifying contribution must be made:

  • in cash
  • to a public charity as described in IRC 170(b)(1)(A), excluding gifts to supporting organizations as described in IRC 509(a)(3) or to a segregated fund or account with respect to which the donor (or donor's designee) has advisory privileges as to distributions or investments (i.e., commonly referred to as a "donor advised fund"), and
  • beginning on August 28, 2005 and ending on December 31, 2005

"Other" non-qualifying contributions are those that occur before the qualifying window (including carryovers of excess contributions from prior tax years into 2005); gifts to supporting organizations or donor advised funds; noncash gifts; and gifts to private nonoperating foundations. To understand the percentage limitation interplay between qualifying and other contributions, see the examples found in Section 301 of the JCT's Technical Explanation of Katrina Emergency Tax Relief Act of 2005.

General Application: In application, donors can now make "qualified" cash contributions to public charities and deduct up to 100% of their "contribution base" through the end of 2005, with any excess deduction carried over up to five succeeding tax years subject to the standard 50% limitation. It is important to note the bill does NOT limit gifts from individuals to organizations or uses associated with Hurricane Katrina relief. In addition, gifts from partnerships and S-corporations are considered as having been made by the partner or shareholder. Only gifts from corporations include such a restriction. Therefore, any public charity regardless of location or mission and donors that support them can benefit from this provision.

Application to IRA Withdrawals: If a donor makes a withdrawal from their IRA, such amounts will gross up their contribution base and, therefore, their ability to deduct gifts of such withdrawals on a dollar-for-dollar basis. However, this may not be without tax cost. Read on.

Side Note: Section 101 of the bill also excludes pre-59 1/2 withdrawals from the 10% early withdrawal tax and allows ratable reporting of income from such withdrawals over three years ONLY for individuals who live within the Hurricane Katrina disaster zone. Presumably, most individuals making withdrawals from their IRAs within the disaster area will not be using them to make charitable gifts; therefore, individuals considering IRA gifts living outside the disaster area should be over age 59 1/2.

Limitation on Itemized Deductions

Current Law: IRC 68 reduces the amount of certain itemized deductions taxpayers can claim by 3% of the amount the taxpayer's income exceeds a specified income threshold. Itemized deductions that are subject to reduction include taxes, interest, most miscellaneous itemized deductions, and charitable contributions. However, these otherwise allowable itemized deductions may not be reduced by more than 80 percent by virtue of the 3% reduction. For 2005, the adjusted gross income threshold is $145,950 ($72,975 for a married taxpayer filing a joint return). These dollar amounts are adjusted for inflation.

New Law: Section 301 provides an exception to the 3% reduction for "qualified charitable contributions."

Application to IRA Withdrawals: University of Missouri Kansas City law professor and PGDC Editorial Board member Christopher R. Hoyt cautions those advocating IRA withdrawals to make larger gifts by stating there can be federal tax consequences of approximately 1% (for married people with AGIs over $145,950) and state tax consequences at any income level:

The protection in the legislation from the limitation on itemized deductions applies to the CHARITABLE GIFT. You will indeed be able to deduct these new charitable gifts, even if the 3% limitation eliminates all of your other itemized deductions."

The problem is taking money out of your IRA to make these gifts. Withdrawing money increases your income and the 3% penalty starts gnawing away at your OTHER itemized deductions (state and local taxes, mortgage interest, etc.), even if your charitable deduction is safe. There is no protection against the 3% penalty against INCREASED INCOME except for the protection you have for the amount of the charitable deduction.

How Is There a 1% Tax?

Under current law, if you are rich and take money out of a retirement that you give to charity, the following happens:

  1. You increase your income by a $100 withdrawal from your IRA.
  2. You make a charitable gift of $100
  3. If your income is over $145,950, you have to reduce your itemized deductions by 3% of the extra $100, or by $3.
  4. That means of your $100 gift, you deduct $97. You lose a $3 deduction.

The loss of $3 multiplied by your 31% tax rate translates to a 1% tax on the charitable gift that you made from your retirement account.

Over-Simplified Example: Donor has $100,000 gross income and $20,000 of itemized deductions. Her taxable income is $80,000 (over simplified). She withdraws $1 million from her IRA and gives it to charity. Now her itemized deductions are $1,020,000. But her income increased to $1,100,000. She is supposed to reduce her itemized deductions by 3% of the extra $1 million: $30,000 (over-simplified). The new law guarantees her a charitable deduction of the full $1 million for the new gift, but she loses the other $20,000 of itemized deductions because her income went up from the IRA withdrawal.

Bottom Line: Taking money out of her IRA to give to charity increased her taxable income from $80,000 to $100,000. She paid extra income tax because of the withdrawal and the gift.

State Taxes? In addition, some states base their income tax on gross rather than taxable income; therefore, the charitable deduction may provide no offset against taxable IRA withdrawals.


Planned gifts have been defined as "any gift the donor has to think about for more than five minutes." This one might require a few more (in order to run the numbers).

While the "indirect" IRA rollover may offer a great opportunity to make a substantial cash gift for some donors, it by no means offers the relative simplicity of the proposed "direct" tax-free IRA rollover. As the sergeant on the television show Hill Street Blues used to always say at the end of roll call, "Be careful out there."

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Example on Impact of IRA Withdrawal on Itemized Deductions

Marc - I agree with everthing you say, but I believe a minor correction is needed in your last example on the impact of the 3% adjustment. As you indicate earlier in the article, other itemized deductions cannot be reduced by more than 80% by virtue of the 3% reduction. Thus, only $16,000 of the $20,000 other deductions is lost, rather than the entire $20,000.

"Indirect" IRA Rollovers

Judging from the lack of any mention of Chartiable Trusts, CGAs, etc., I assume the bill does not include any provision for use of these instruments. Any guidance on this issue? Thanks, Michael George The Catholic Foundation Dallas, Texas

3% limit -- IRA withdrawals for charitable gifts

Tom Wesely's observation about the 3% phase-out is correct. There is an 80% limit on the amount of itemized deductions that are eliminated. Again, it was an over-simplified example to illustrate the problem. There are indeed other income tax ramifications from withdrawing money from retirement accounts to make charitable gifts. To illustrate, the example completely ignores the existance and the gradual phase-out of the $3,200 personal exemption as income increases. The purpose was simply to provide an over-simplified illustration of some of the tax ramifications and to show that charitable gifts funded with IRA withdrawals will not be free from income tax consequences. I'll have a handout on the new law and the planning implications at the NCPG Conference in Orlando on Thursday. Hope that everybody survived Hurricane Rita as best as could be hoped. Chris

Indirect IRA Rollovers to CRTs and CGAs

Michael, The JCT explanation of the bill does contain the following statement: "Under the provision, qualified contributions must be to an organization described in section 170(b)(1)(A); thus, contributions to, for example, a charitable remainder trust generally are not qualified contributions, unless the charitable remainder interest is paid in cash to an eligible charity during the applicable time period." Although transfers to CGAs are considered part outright gift and part purchase of annuity contract (and therefore might satisfy the above requirement), the bigger problem is the donor is receiving only a partially offsetting (roughly 30% in most cases) charitable deduction. Thus, 70% of the IRA withdrawal remains taxed. If I were a donor considering such a plan, I would definitely wait for more favorable legislation.

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