Charity rules change, sometimes for better
By HELEN HUNTLEY
Published August 20, 2006
If you're feeling charitable, be sure to read this column before writing your next check. The tax rules on donating money to charity have changed in some important ways.
The good: If you hate taking required distributions from your IRA and you don't really need the money, now you can give it to charity and bypass the IRS.
The not-so-good: If you put cash in the collection plate, you'll need a receipt if you expect to deduct the donation on your income tax. In the past, you only had to get a receipt for donations of $250 or more. And you can't get a write-off any more for clothes or household goods in poor condition.
The changes are part of the pension reform bill Congress just passed and President Bush signed last week. The new rule on donating IRAs to charity could have a big effect, said Theresa Fry, manager of IRA distribution planning for AG Edwards & Sons.
"A lot of people want to see their money go to good use during their lifetimes," she said. "They don't want to wait until death to make those gifts."
In the past, making an IRA donation was convoluted: withdraw the money, pay taxes on it, donate it, then claim a charitable deduction. Besides the hassle, that approach had one major flaw:
"If you take a dollar of income and a dollar of deduction, they generally don't offset," said Tampa CPA Greg Rosica at Ernst & Young.
First, you have to have enough deductions to make it worthwhile to itemize. That's not the case for many retirees who no longer have mortgages. In addition, deductions are phased out for high income taxpayers, so they don't get the full benefit of their charitable donations.
Now those who are at least 70½ years old can give IRA money directly to charity, have it count as part of their required distribution for the year and never pay taxes on it.
"This can lower your income and maybe even cut down the tax you pay on Social Security income, not to mention the loss of tax deductions, exemptions and tax credits that are lost when your income is increased," said IRA expert and author Ed Slott. "If you normally make donations anyway, you should now make those donations from your IRA."
To qualify, the check has to be written directly from the IRA to the charity. IRA trustees will have to work out the mechanics of doing that, perhaps by offering IRA checkbooks. The donations cannot exceed $100,000 a year and must be to IRS-recognized charities, excluding donor-advised funds.
If you have some other type of retirement account, such as a 401k, you'll have to roll it over to a traditional IRA before applying this technique. If you have pretax and aftertax money in your IRA, the contribution will be considered to come from the pretax part. Donations can be made from Roth IRAs, although you probably wouldn't want to since Roth withdrawals are tax-free in most instances.
There's no double dipping. If you make a direct donation of pretax money, you can't take a charitable deduction. The rule applies to contributions made before Jan. 1, 2008.
The change that will affect the most people is a rule requiring substantiation for cash contributions. Now you need a receipt, a canceled check or a bank statement showing the transaction.
"It will force people to use credit cards or checks," Rosica said.
Congress decided to get tougher on property donations. Donated clothing and household goods must at least be in "good" condition to claim a deduction unless the item is appraised for $500 or more.
In addition, for businesses to claim deductions for their donations, food inventories must meet quality standards and books given to public schools must be used by the schools.
Other rules affect donations of conservation easements and fractional interests in personal property.
Question: We have saved diligently for retirement. However the bulk of our savings are in my name because my employer had the better matching. My wife will be 59½ years old four years before me. We would like to be able to draw from these IRAs as soon as possible.
You cannot transfer an IRA or other retirement account from one living person to another, except in a divorce settlement. You do have a couple of other options. You can withdraw money from a company retirement plan without penalty if you leave your job at age 55 or older. Or, if you are working, you might be able to borrow from the plan.
If you have an IRA, you can take penalty-free annual withdrawals based on your life expectancy so long as you are careful to follow the rules and continue the withdrawals for at least five years or until you are 59½, whichever is later.
Although these methods avoid penalties, you will be liable for income taxes.
Helen Huntley writes about investing and markets for the Times. If you have a question about investments or personal finance, write email@example.com or Helen Huntley, Times, P.O. Box 1121, St. Petersburg, FL 33731. Read more questions and answers at www.sptimes.com/blogs/money