Don't Mess With Taxes

OK, I'm on a charity kick right now. Chalk it up to the impending giving season. I don't want to overdo, but I recently received some reader inquiries on a new charitable option.

Specifically, a provision of the Pension Protection Act that was signed into law in August, allows taxpayers who are 70½ to directly transfer money from an IRA to a charitable organization. By doing so, these filers don't have to include the transferred money in taxable income.

Some of you might be asking, what's so special about 70½? Well, aside from skewing my demographics (but, hey, I am the one who included an AARP link in an earlier post), it's an important milestone for the individual and the IRS, but for a more practical reason.

An owner of a traditional IRA must start taking some money from the plan by April 1 of the year following the year the account holder celebrates his or her 70½ birthday. (Doesn't everyone have a half-year birthday party? I know I welcome any excuse for cake.)

Even if you don't need the money, the IRS says you've got to take some of your IRA funds out (the exact amount, referred to as a required minimum distribution, is based on the table discussed here) because Uncle Sam is tired of waiting for taxes that have been sitting in the account, deferred, for years.

But this year and in 2007, if you don't need the IRA money, you can instead shift it -- as much as $100,000 each year -- directly to your favorite charity. That way it doesn't count as taxable income to you since you never got your hands on it. The drawback: You can't deduct the gift.

So that got blog reader Carol wondering if there's a way to determine whether it's more beneficial for a retired taxpayer to (1) withdraw the IRA money, donate it to a charity and take the deduction, or (2) donate directly via the rollover option, avoiding the tax on the IRA withdrawal but forfeiting the deduction.

As with most tax questions, the answer is, "It depends." 

First, the deduction consideration. The general assumption is that it would be better for a retiree to directly roll over the donation because most senior filers don't itemize, which is necessary to deduct donations. They've probably already paid off (or way down) their mortgages so they have no (or little) interest to deduct. And, in most cases, they're probably receiving age-related property tax exemptions that help keep that deductible payment below the standard deduction amount.

For 2006 returns, that standard amount is $6,400 for a single filer 65 or older; $12,300 if married filing jointly and both husband and wife are 65 or older. That's a nice bump up from the "standard" standard amounts of $5,150 and $10,300, respectively, for younger taxpayers.

In all cases, whether 30½ or 70½, if your itemized deductions, including charitable donations, don't exceed the standard amount, then you get no tax value from your philanthropy.

Then there's the taxable income consideration. Lawmakers also presumed that many older filers would welcome the chance to give to a charity without having to add IRA distributions to their taxable income. This is of particular concern when such distributions push the taxpayer over the earnings threshold that then makes part (possibly up to 85 percent) of their Social Security benefits taxable, too.

Of course, every tax situation is individual, so the best of legislative intentions might not work at all for some older filers. If you or a friend or relative can use this rollover option, you and they probably should do your taxes both ways, figuring your IRS bill when you take a regular taxable distribution and deduction vs. using the tax-free rollover. Obviously, the method that gets you a lower bill is the one to use.

No one likes doing more tax computations than necessary, but it's relatively easy to run the numbers if you tax software. And the extra time could produce welcome tax savings.

One other note: This rollover option applies to both traditional and Roth IRAs, although not many Roth account holders will find it useful. If you've had your Roth for at least five years and you're at least 59½ years old, then the earnings on the already taxed money you put in can be taken out tax-free.

A few words about tax inquiries: While I do read every comment I get, I don't have the time to answer them all. I've got to actually make a living.

And then there's the hubby, who already is a tad jealous of the time I spend on taxes and blogging about them (even though I've made him a star via Don't Mess With Taxes).

Finally, I am not a professional tax preparer (see my disclaimer,  I gotta tell ya ...). I do my homework, take classes to keep up to speed, and read, read, read about taxes. But I am a writer.

I deal primarily in overviews of taxes applicable to a wide, general audience.

I don't provide specific advice in individual cases.

So if you wrote me about your unique, convoluted tax situation, I will do my best to point you in the right direction, but that's it. And if you wrote and haven't heard back from me, it's because I haven't had time to consult my tax map for the appropriate directions.