Year-end planning: Timing of charitable gifts, and type of property contributed, can be important

Charitable contributions should be timed so as to obtain the maximum tax benefits, either in 2013 or 2014. If a taxpayer plans to make a charitable contribution in 2014, he should consider making it this year instead if speeding up the deduction would produce an overall tax saving, e.g., because the taxpayer will be in a higher marginal tax bracket in 2013 than in 2014. On the other hand, a taxpayer who expects to be in a higher bracket in 2014 should consider deferring a contribution until that year. Taxpayers also should be mindful that the special tax break for direct contributions from individual retirement accounts (IRAs) expires at the end of this year.

In making any sizeable charitable contributions, to the extent possible, clients should make the contributions in appreciated capital gain property that would result in long-term capital gain if sold. That way, a deduction generally is obtained for the full value of the property, such as shares of stock, etc., while any regular income tax on the appreciation in value is avoided. (However, for tangible personalty, this favorable treatment is only available if the donated item is related to the exempt purpose of the donee charity.)

RIA recommendation: If a client owns appreciated property which he expects to appreciate still further in value, and which he wants to continue to hold so as to benefit from the additional appreciation, the client should consider using cash that he would otherwise contribute to charity to buy additional property of the same type and contribute the property he first owned to charity. Not only will he get a deduction equal to the full fair market value of the property he contributes to charity, he will have a higher basis in the newly acquired property, thus reducing the amount of gain he will recognize if he sells it.

It should be noted, however, that contributions of appreciated capital gain property generally are subject to a 30%-of-AGI (adjusted gross income) ceiling, instead of the usual 50% ceiling, unless a special election is made to reduce the deductible amount of the contribution.

RIA observation: Making the election will limit the donor’s deduction to the basis of the contributed property. In most cases, the election should be made only if the fair market value of the property is only slightly higher than the basis of the property.

IRA distributions to charity. Older taxpayers who plan to use IRA distributions to make charitable contributions should bear in mind that the favorable tax provision for doing is slated to expire at the end of this year. This provision, Code Sec. 408(d)(8), allows taxpayers age 70 1/2 or older to take advantage of an up-to-$100,000 annual exclusion from gross income for otherwise taxable IRA distributions that are qualified charitable distributions. Such distributions aren’t subject to the charitable contribution percentage limits and aren’t includible in gross income. Since such a distribution is not includible in gross income, it will not increase AGI for purposes of the phaseout of any deduction, exclusion, or tax credit that is limited or lost completely when AGI reaches certain specified levels.

To constitute a qualified charitable distribution, the distribution must be made after the IRA owner attains age 70 1/2 directly by the IRA trustee to a Code Sec. 170(b)(1)(A) charitable organization (other than a Code Sec. 509(a)(3) organization or a donor advised fund, as defined in Code Sec. 4966(d)(2)). (Code Sec. 408(d)(8)(B)) Also, to be excludible from gross income, the distribution must otherwise be entirely deductible as a charitable contribution deduction under Code Sec. 170 without regard to the charitable deduction percentage limits. (Code Sec. 408(d)(8)(C))

Even though a direct distribution from an IRA to a charity is not included in the taxpayer’s gross income, it is taken into account in determining the owner’s required minimum distribution (RMD) for the year.

As shown below, making direct contributions under this provision will save more taxes than taking an IRA distribution and making a contribution from the proceeds. Under Code Sec. 408(d)(8)(F), qualified charitable contributions aren’t available for distributions made in tax years beginning after Dec. 31, 2013. Thus, unless the provision is extended as it has been in the past when it expired, this may be the last opportunity to achieve the tax savings offered by this provision.

RIA illustration : Jason, who is age 73, is the owner of a traditional IRA with a balance of $300,000, consisting solely of deductible contributions and earnings. He wants to make a contribution of $100,000 to his college before the end of 2013 to mark the 50th anniversary of his graduation. Jason, who is a widower and files his tax return as a single taxpayer, expects to have AGI of $110,000 in 2013, itemized deductions of $25,900 (before taking the $100,000 contribution to his college into account), and a personal exemption of $3,900 in computing his taxable income. The itemized deductions of $25,900 include $20,000 of other contributions to public charities. If Jason takes a distribution of $100,000 from his IRA, his AGI for 2013 will be increased to $210,000. If he then contributes the $100,000 to his college, it will only increase his total charitable deduction by $85,000 ($105,000 [1/2 of AGI of $210,000] less the $20,000 of other charitable contributions he has made). His itemized deductions will be $110,900 ($25,900 plus $85,000), and his taxable income will be $95,200 (AGI of $210,000 less itemized deductions of $110,900, and less personal exemption of $3,900). Jason’s income tax for 2013 will be $19,949.25.

If instead, Jason had the Trustee of his IRA transfer the $100,000 directly to his college, his AGI would not increase and he would not be entitled to a charitable contribution deduction for the amount transferred from the IRA. His AGI would remain at $110,000, his taxable income would be $80,200 ($110,000 less itemized deductions of $25,900, and less his personal exemption of $3,900), and his income tax for 2013 would be $15,978.75, or $3,970.50 less than under the scenario where he takes a distribution of $100,000 from his IRA and then contributes it to his college.

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