At the end of December, the provision for Qualified Charitable Distributions expired.That provision allowed taxpayers 70.5 or older to make direct distributions from an IRA account to a qualified charity, bypassing recognition of the distribution as income.
With the expiration of this provision, you can still make charitable contributions of money from your IRA.
The difference is that these contributions are no different from a contribution you’ve made from your savings account or regular income.
To achieve a tax advantage from the contribution, you will itemize the charitable contribution on your tax return. (Of course, if the money is from your IRA you’ll also have to recognise the distribution as income.)
You can still make charitable contributions of money from your IRA, but the new year brought new rules.
Let’s look at both ways to understand what’s different.
The old way
Under the expired provision, if you qualified you could make a direct distribution from your IRA account to the qualified charity of your choice and, when ready to file your tax return for the year, not include the amount of the direct distribution to the charity as income. This could also include your Required Minimum Distribution for the year, as well.
By doing this, you didn’t have to recognise this income at all — which doesn’t seem so important until you see how it works in the new way.
The new way
Now that the QCD provision has expired, you can still make charitable contributions from your IRA, but it’s not as advantageous as the old way. Under this method (which can be enacted by anyone over age 59.5 without penalty) you take a distribution from the IRA, then send it to the charity of your choice.
(In actuality, the distribution doesn’t have to be from an IRA, but we’re doing a compare and contrast against the expired QCD arrangement, so that’s what we’ll use for the examples.)
Now when you get around to filing your tax return for the year, you’ll have to recognise the distribution from your IRA as income. Later on in the return you can include the charitable contribution as an itemized deduction, eventually lowering your taxable income by the same amount.
Since you have to include the distribution as income, though, this will increase your overall income (unless you have net operating losses from your business to offset the income), and will therefore also increase your adjusted gross income (the bottom line of your Form 1040). The significance to this is that many tax provisions depend upon the adjusted gross income figure.
An example is deductible medical expenses — these are only deductible to the extent that they are in excess of 7.5% of your AGI. Miscellaneous Itemized expenses are subject to a similar “floor”: they must be greater than 2% of your AGI to be deductible. In addition, certain phase-outs are affected by AGI level.
Another area that could be significantly affected is Social Security taxation. If your income is at a level where your Social Security benefit is taxed at less than the maximum 85% rate, including the IRA distribution in your income (under the 2012 method) would likely increase the taxation rate, possibly up to the maximum.
So you can see that increasing your income can have a significant impact on your overall tax return. Here’s a quick example of how this could affect a taxpayer:
The taxpayer is single, 73, and subject to RMDs from his IRA. He wishes to make a charitable contribution of $50,000 from his IRA funds to his church. If this were 2011, he could make his distribution directly.
Here’s how his tax return worked out:
Income (pension and IRA, plus his $10,000 additional distribution): $50,000
Adjusted gross income: $50,000
Medical expenses: $10,000
Deductible medical expenses (above 7.5% of AGI):$6,250
Charitable contributions $10,000
Taxable income> $39,050
Under the 2012 method, the taxpayer takes the distribution from an IRA and then sends it to a church.
Here’s how the tax return works out now:
Income (pension and IRA, plus his $10,000 additional distribution): $60,000
Adjusted gross income: $60,000
Medical expenses: $10,000
Deductible medical expenses (above 7.5% of AGI): $5,500
Charitable contributions $11,000
Taxable income> $39,700
Under the new method, the tax cost was increased by $67. This doesn’t seem like a lot, but if the circumstances were a bit different this could become sizable — and who likes to pay extra taxes of any amount?
Bear in mind that this provision has expired and subsequently been extended in the past, so it’s possible it could be extended again at some point in the future. Stay tuned.