The Pension Legislation’s Big Nod to Charity (and Your Client’s Taxes)

The Pension Protection Act (PPA) that Congress passed at the start of the month—and which President Bush is expected to sign into law on Thursday—deals largely with the nation’s ailing pension system. But it also includes a landmark charitable-giving incentive that will help older, wealthy clients give six-figures tax free to their favorite charities.

The Pension Protection Act (PPA) that Congress passed at the start of the month—and which President Bush is expected to sign into law on Thursday—deals largely with the nation’s ailing pension system. But it also includes a landmark charitable-giving incentive that will help older, wealthy clients give six-figures tax free to their favorite charities.

For clients older than 70 1/2, the legislation allows tax-free distributions from traditional or Roth Individual Retirement Account (IRA) assets, up to $100,000 per year. The only restriction is that the donations be made directly to qualified public charities. The result, effectively, is a tax-free rollover of funds for charitable use. The law will be applied to gifts completed by Jan. 1, 2008, when it is then scheduled to sunset. (By qualified charity, the government means only charities as defined by Internal Revenue Code, Section 170(b)(1)(a); most public charities are fine, but it excludes private foundations, donor-advised funds and supporting organizations.)

“This is a very big deal,” says Conrad Teitel, an estate-planning attorney with Cummings & Lockwood in Stamford, Conn., who has been lobbying Congress since 1982 for this kind of a measure. “It’s very good for people over 70 years old who wish to donate,” he says, “and, of course, will be a wonderful new source of funds for charities.”

Up until now, wealthy clients who wanted to donate IRA funds may have shied away because they weren’t able to completely deduct the gift for federal income-tax purposes—due to the 50 percent of adjusted gross income (AGI) limit. Take, for example, Richard Rich, a 71-year-old donor. He has an AGI of $85,000, but, in the pre-PPA world, upon withdrawing $100,000 from his IRA, Rich’s new AGI would be $185,000. If he gave the $100,000 to charity, his deduction would be limited to 50 percent of his AGI, or $92,500. He would then owe tax on $7,250 worth of the income he gave to charity. Under the PPA law, the $100,000 is not reported as part of Rich’s AGI. And, therefore, it doesn’t need to be deducted on his tax return.

For clients who would have been able to give the $100,000 without going over the 50 percent AGI limit, the new law is still useful. Since the donor doesn’t have to report the withdrawal, their AGI doesn’t increase and they don’t miss out on other federal income-tax deductions and credits that phase out as AGI goes up, says Robert Sharpe, president of The Sharpe Group, a planned-giving consultant to the nonprofit community.

An additional reason to make gifts using IRA funds: They are subject to both income and estate tax if left to heirs. Even if Congress eliminates the estate tax—it was unable to do so last month—income tax will still be due on IRA funds left to heirs, making them ideal for funding charitable gifts at death.

Says Teitel: “It would be wise for any advisor to know what the rules are here, and what his clients are doing and what they’re thinking, even if there isn’t any money for them in it—it’s being there and being able to explain it that makes the advisor valuable.”

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