Waiting on Congress used to be the rule rather than the exception when it came to tax legislation. That was until the passage of the Protecting Americans from Tax Hikes Act signed into law by President Barack Obama on Dec. 18, 2015.
For any charitably inclined individuals over 70 and a half years old with an individual retirement account, planning is now an option rather than the wait and see approach we were stuck with since the original expiration on Dec. 31, 2007. Typically extended two taxable years at a time, the political process was delayed further and further until it got so bad in 2012 that was retroactively reinstated by Obama the following year.
By removing subparagraph F of section 408(d)(8) of the Internal Revenue Code, Congress made permanent the ability for individuals over 70 and a half years old to make distributions directly from their IRA to charity. Qualified charitable distributions cannot exceed $100,000 per taxpayer per year, but do count toward satisfying the individual’s required minimum distribution.
The key here is a taxpayer is not limited by the amount of his or her RMD and the qualified charitable distribution can still be made to the full $100,000 limit, even if the RMD is less. It is important to note direct distributions to charity do not include transfers to donor advised funds or private foundations.
Not only is the direct charitable contribution excluded from adjusted gross income, but it is not exposed to the normal charitable contribution limits for taxpayers who itemize their deductions on schedule A of form 1040, a deduction limited up to 50 percent of AGI with the ability to carry forward excess contributions over the next five years. In fact, this law allows taxpayers that don’t itemize their deductions to benefit from charitable contributions.
It also is important to remember that because so many tax calculations are based on AGI, by never including the IRA distribution in that total a taxpayer might be able to take more in itemized deductions – medical and miscellaneous – and potentially avoid the Pease limitation on itemized deductions or exposure to the 3.8 percent Medicare surtax.
With IRAs becoming a larger percentage of an individual’s wealth, a direct distribution from your IRA to charity is an excellent way to satisfy your charitable gifts. However, there is another alternative for taxpayers of all ages, depending on what’s in your portfolio.
The gift of long-term appreciated securities is another powerful technique for satisfying your charitable gifts. Although the deduction for gifts of long-term appreciated assets is limited to 30 percent of AGI, rather than the typical 50 percent limitation, don’t forget the five-year carry forward. A charitable deduction for the fair market value of the securities contributed, combined with the savings of the capital gain tax had you sold the securities, is quite powerful.
A very real example right here in our own backyard would be O’Reilly Automotive Inc. (Nasdaq: ORLY). Assume you were smart enough to buy 500 shares 10 years ago for $33 per share. You would have a cost basis equal to $16,500.
With ORLY trading around $260 per share at the time of this article, that would translate to a current fair market value of $130,000 or an unrealized gain of $113,500 on your 500 shares.
If you were to give those shares to your local church, you would have a charitable deduction of $130,000 – subject to the 30 percent limitation this year – but assuming you are in the 35 percent marginal federal bracket – 25 percent capital gains rate – you can probably take the bulk, if not all, of the deduction this year, resulting in a total tax savings of $28,375 in capital gains never triggered and $45,500 in income tax avoided.
Obviously, these tax calculations are generalized and assume many things contained in the thousands of pages of federal tax code that might otherwise apply to your individual situation, modifying the end result. As you gather your tax statements and make your appointments with your certified public accountant and financial adviser to go over what happened last year, don’t forget to plan for this year. This is a great time to discuss what makes the most sense for you and your individual situation.
Steve Kamienski is vice president and relationship manager for Central Trust Co. He can be reached at steven.kamienski@centraltrust.net.
