Don't Mess With Taxes

This post was updated March 27, 2017. Original text can be found here.

Uncle Sam encourages us to save for retirement by offering a variety of tax breaks. However, in the case of tax-deferred retirement plans, such as traditional IRAs and 401(k) workplace retirement accounts, he eventually wants his share of tax on our nest eggs.

Are you comfortable enough in your golden years to share some of your IRA money with your favorite charity? That option now is a permanent part of the Internal Revenue Code.

This is accomplished via required minimum distributions, or RMDs.

But the tax code also offers a way to meet annual required withdrawals without owing tax. You can donate your RMD directly to a qualified charity.

This option was made a permanent part of the tax code in December 2015 as part of the extenders, popularly known as the Protecting Americans from Tax Hikes (PATH) Act.

Now IRA owners age 70½ or older can make a direct transfer from that retirement account of up to $100,000 to an eligible charity. If you're married and file a joint return, your spouse can also make his or her own direct IRA donation of up to 100 grand.

Long-standing donation option: This option, first available in 2006, can be used for distributions from any IRA, but it's particularly welcome by account owners who must take an RMD from their traditional IRA(s).

Known as a qualified charitable distribution (QCD), this allows you to meet your mandated annual withdrawal amount, but because the money goes directly to a charity, you don't face any taxes on the mandatory distribution amount.

Even better, you don't have to worry if you've made both deductible and nondeductible contributions to your traditional IRAs. A special rule treats amounts distributed to charities as coming first from taxable funds, instead of proportionately from taxable and nontaxable funds, as would be the case with regular distributions.

The one downside for seniors who itemize is that they don't get to claim a deduction for the transferred charitable gift. However, avoiding a chunk of taxable income is a pretty darn good tax break.

Some limitations: Note, however, that there are limitations.

The most obvious one is the age requirement. I you're not yet a septuagenarian (and a half), you can't take advantage of the IRA-to-charity transfer.

Also, the option doesn't apply to all retirement accounts. Distributions from employer-sponsored retirement plans, including SIMPLE IRA plans and simplified employee pension (SEP) plans, are not eligible.

And not all charities are eligible. For example, donor-advised funds and supporting organizations are not eligible recipients.

Finally, make sure that the distribution donation is transferred directly by the IRA trustee to the eligible charity. If you take the RMD, you'll still owe taxes on the amount, even if you subsequently give it all to your favorite IRS-approved nonprofit.

QCD paperwork: When you make a charitable distribution from your IRA this way, you'll get confirmation of the gift on a Form 1099-R from the charity for the calendar year the distribution is made.

Then you'll need to let the IRS know.

To report a QCD on your Form 1040 tax return, you generally enter the full amount of the charitable distribution on the line for IRA distributions. On the line for the taxable amount, enter zero if the full amount was a qualified IRA donation and write "QCD" next to this line.

You also might need to file Form 8606, Nondeductible IRAs, if you donated your RMD from a traditional IRA in which you also took out money for your own use that same tax year.

If you use tax software, it should help you complete these filing tasks regarding your donated RMD. Form 1040 instructions also have more info.

Yes, it's a bit more work to make the direct QCD and report it on your taxes. But it's also a good way to help out your favorite charity, meet your annual RMD and not owe any tax.

You also might find these items of interest:

• 4 tax breaks for older filers
• Some of VP Joe Biden's Social Security is taxed. Is yours?
• We can't stop Father Time, but we can prepare physically, emotionally and financially