In the last edition of our newsletter, we discussed the anticipated changes relating to IRAs and other qualified retirement accounts. Since that newsletter issued, nothing much has changed. The House of Representatives passed the SECURE Act and the Senate version, RESA, still has not been the subject of a vote. While it is anticipated that RESA will ultimately be passed by the Senate, until that occurs and the differences between the two bills are reconciled, it is not possible to identify what changes will be implemented, other than that the start date for required minimum distributions (RMDs) will be delayed and the ability of beneficiaries to extend the time within which they can take distributions will be significantly curtailed.
In this article, we will discuss a tax savings strategy that can be implemented irrespective of the anticipated changes reflected in the SECURE Act and RESA.
In 2017, Congress passed the Tax Cuts and Job Act (the “Act”) which purportedly reduced the tax obligations of middle and lower class taxpayers. Among the changes to the Tax Code, the Act limited the deduction on mortgage interest to the first $750,000 of the loan. Interest on home equity lines of credit taken after the enactment of the Act are no longer deductible. A single filer’s standard deduction increased from $6,350 to $12,000 and the deduction for married and joint filers increased from $12,700 to $24,000. Significantly, the Act limited the amount that can be deducted for state and local taxes to $10,000. As a result of this cap, the vast majority of our clients who took itemized deductions in the past now use the standard deduction. In fact, it is estimated that 94% of taxpayers will take the standard deduction.
Prior to the Act, charitable contributions, together with interest on mortgages and property taxes, could be itemized and deducted from taxable income. Under the Act, it only makes sense to itemize if all of your deductions, including charitable contributions, exceed the higher standard deduction. However, with proper planning, it may still be possible to utilize charitable donations to reduce your tax liability.
Distributions from a traditional IRA are taxed as ordinary income because the original contributions to the account were made with pre-tax dollars. Account owners must begin taking required minimum distributions (RMDs) at age 701/2. However, since 2015, up to $100,000 can be donated to a qualified charity without it being considered a taxable distribution. To take advantage of this strategy and offset the RMD with charitable donations, it is necessary to adhere to the IRS’s rules for qualified charitable distributions (QCDs), also called charitable IRA rollovers. The donation must be made directly from the retirement account. It cannot be made by the account owner after receiving the RMD. The donation must be made to a qualified charity directly from the IRA. Generally, churches, nonprofit charities, educational organizations, nonprofit hospitals and medical research organizations are qualified charities, although it is best to confirm this with the charity you intend to benefit. The charity receiving your donation will not have to pay taxes on your contribution. Abiding by these rules will allow you to satisfy your RMD by paying the funds directly to the charity. This avoids tax on the RMD and satisfies the charitable intention of the account owner. Each spouse of a married couple can take advantage of this strategy.
If you are itemizing deductions, you must elect whether to report the income and claim the deduction or direct the payment of the charitable donation from the IRA. You cannot claim both for the same distribution. However, if you make other charitable donations that do not use your IRA funds or which exceed the standard deduction together with your other deductions, you can still claim each of the donations as an itemized deduction and realize a tax benefit. If you do not itemize your deductions and take the standard deduction on your return, a charitable IRA rollover will give you a tax break for the donation.
In sum, if you are over 701/2, are utilizing the standard deduction and intend to make donations to qualified charities, making those donations directly from your retirement accounts in an amount that is not greater than the smaller of your RMD and $100,000 will provide a tax benefit and should be utilized. At Berwitz & DiTata LLP we can assist you and explore whether this strategy is beneficial for you.