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Charitable Transfers Get Maximum Return on 'Minimum Distribution'

NEW YORK ( TheStreet) -- One of the temporary benefits extended for tax year 2013 by the American Taxpayer Relief Act of 2012 was the ability for people age 70.5 and older to transfer up to $100,000 tax free directly from an IRA account to a qualifying charity. These charitable transfers can be used to satisfy the taxpayer's "required minimum distribution" for the year.

Using this technique can result in substantial tax savings. Here is how it works:

Dave Donor, 72, must take a fully taxable required minimum distribution of $4,263 from his IRA this year. Dave also owes $5,000 on a pledge to the Visual Art Center of New Jersey building fund. He can contact the trustee of his IRA account and request that $5,000 be sent directly from the account to the center to cover his required minimum IRA distribution for 2013 and his pledge. The $5,000 is not reported as income on his 2013 Form 1040, but he cannot deduct it as a charitable contribution on his Schedule A.

If this tax benefit had not been extended, Dave would have had to claim $4,263 as gross income on Page 1 of his Form 1040 and claim a $5,000 charitable deduction on Schedule A. The $4,263 would increase his Adjusted Gross Income and could, as a result, increase the taxable portion of his Social Security (or Railroad Retirement) benefits by as much as $3,624, reduce his medical and miscellaneous itemized deductions by up to $426 and reduce or eliminate a number of other deductions and credits affected by AGI, possibly causing him to fall victim to the dreaded Alternative Minimum Tax.

Now the $5,000 IRA transfer is tax free and does not increase his AGI. The additional $737 represents a tax-free withdrawal from his IRA.

There is nothing in the law that limits the number of transfers that can be made during the year, or the number of charities to which the money can be transferred. So Dave can choose to transfer $1,000 each to four different churches or charities and $263 to a fifth. The only requirements are:

  • The taxpayer must be at least 70.5 years old and subject to the required minimum distribution rules.
  • The distribution must be a direct trustee-to-trustee transfer. The IRA trustee must transfer the money directly to the charity; taxpayers cannot get the distribution in their hands, then donate it to the charity.
  • One hundred percent of the transfer must qualify as a charitable contribution eligible to be deducted on Schedule A.
  • The maximum amount that can be excluded from taxable income for the year is $100,000.

Many retired taxpayers who must take a Required Minimum Distributions from an IRA are not able to itemize, due to the additional standard deduction for age 65 or older and the fact that their mortgage is paid off; they therefore get no tax benefit from their charitable contributions. By using a direct transfer to the charity of their choice to satisfy their annual required minimum distribution they will be able to get the full tax benefit for their contribution, as well as possibly reducing their taxable Social Security.