Charitable distributions: Pension Protection Act may bring windfall to nonprofits.

While philanthropy continues to be important to our communities, a provision in a recently passed law may make charitable contributions even more pervasive.

The Pension Protection Act of 2006 (PPA) may provide a boost to charitable organizations by permitting older taxpayers to donate--tax-free--up to $100,000 from an Individual Retirement Account, each year for the next two years, to a charitable cause.

How It Works

For years 2006 and 2007, PPA Sec. 1201 will allow IRA owners older than 70 1/2 to roll over up to $100,000 directly to one or more public charities. Therefore, a married couple could donate up to $200,000, provided that each spouse owns at least one IRA.

These qualified charitable distributions (QCDs) are defined as any distribution made directly to an organization described in IRC Sec. 170(b)(1)(A). Thus, "qualified charitable organizations" include public charities and private operating foundations to which the 50-percent income tax deduction limitation applies. Private non-operating foundations are excluded, along with supporting organizations and donor-advised funds.

However, field-of-interest funds, designated funds, scholarships and restricted or general endowments, for which donors or their designees have no advisory rights, are considered suitable QCD recipients.

QCDs must come only from regular and Roth IRAs. A charitable distribution from a regular IRA is preferable, since Roth IRAs already allow tax-free distributions. Distributions from other forms of retirement plans--such as 401(k), 403(b) annuities, defined benefit and contribution plans, profit-sharing plans, Keoghs and employer sponsored SEPs and SIMPLE plans--are not eligible.

For some donors, it's possible to establish an IRA and then simply roll over assets to it from another plan. This IRA may then make a QCD. Note that QCDs may include only amounts that otherwise would be taxable if distributed directly to the IRA participant.

Some owners, however, make nondeductible contributions to their IRAs that, if withdrawn, would be considered a tax-free return of nondeductible contributions. Such distributions are not deemed acceptable as a QCD.

How It's Reported

With the IRA rollover, there is no charitable income tax deduction for the distributions, and the distribution itself is not included in the donor's taxable income. This should simplify tax reporting and provide potential favorable tax benefits resulting from a lower adjusted gross income.

It's important to note that the new rules apply only to outright lifetime transfers from IRA owners. The rules and benefits applicable to testamentary transfers are unchanged.

The distribution must be delivered or postmarked to the charity no later than Dec. 31 of the year for exclusion. Distributions that do not meet the new rule's requirement are treated under existing rules. In essence, they will be taxable to the plan participant, who must then claim an itemized income tax charitable deduction after the contribution.

Benefit to Taxpayers

These IRA rollover gifts could easily amount to $1 billion or more during 2006 and 2007, according to Federal Reserve surveys.

Taxpayers expected to take advantage of this new break include those older than 70 1/2 with well-funded IRAs, who have more than enough to live on or give to their heirs. Their required minimum distributions (RMDs) are taxed anyway, so a QCD may substitute for some other charitable contribution they would otherwise make.

Another group expected to benefit are those individuals who don't itemize deductions. Such taxpayers will be able to avoid taking the QCD into income, resulting in lower taxable income.

Also, Social Security recipients already may be taking an IRA-required distribution that increases their income to a level where as much as 85 percent of their Social Security is taxable. Because a QCD is not included in income, only 50 percent of their Social Security receipts may be taxable.

Finally, major donors may choose to give the full $100,000 per year and avoid an additional $100,000 of reportable taxable income. This may result in substantial income tax savings not otherwise available due to deduction floors and phase-outs at higher income levels.

The Road Ahead

Many IRA owners delay taking distributions until November or December for two principal reasons. First, the longer the funds are in the IRA, the more time there is to benefit from tax-free growth. Second, many IRA owners do not necessarily need the IRA income to cover living expenses.

Major financial services companies and charities are expected to make it easy to complete a QCD--donors or their advisers simply contact the IRA's custodian to arrange for the distribution. An added bonus is that a QCD made by Dec. 31, 2006 will qualify for all or part of the IRA owner's 2006 RMD.

And IRA custodians and trustees have some say in the program. They can establish criteria so that they need not process contributions in small dollar amounts.

All in all, many types of donors and their advisers are expected to favor QCDs to simplify taxes and keep income levels lower, resulting in a windfall for charities.

Philip R. Lieberman, CPA, is a director at Irvine-based Clearview Financial Services, which provides advisory services on wealth transition strategies and business succession planning. You can reach him at [e-mail]. For more info on the Estate Planning Committee, visit www.calcpa.org/estate.

By Philip R. Lieberman, CPA