Year-End Tax Advice: Essential 2013 Knowledge

Editor's Note: This article is part of our 2013 Tax Tips series. Robert Flach is an expert with almost 40 years of experience as a tax professional and also blogs as The Wandering Tax Pro.

NEW YORK (MainStreet) — Do you have to take a required minimum distribution (RMD) from your IRA account this year, but have yet to do so?

Taxpayers age 70½ and older can directly transfer up to $100,000 tax-free from an IRA account to a charity. This charitable transfer can be used to satisfy your required minimum distribution for the tax year.

Ely Mosynary, age 72, must take a fully taxable required minimum distribution of $4,263 from his IRA. Mosynary also owes $5,000 on a pledge to the Visual Art Center of New Jersey building fund. He can contact the trustee of his IRA account and request that $5,000 be sent directly from his account to the Visual Art Center of New Jersey to cover both his required minimum IRA distribution for 2013 and his outstanding pledge. The $5,000 is not reported as income on his Form 1040, but he cannot deduct the $5,000 as a charitable contribution on his Schedule A.

If Mosynary received the $4,263 from his IRA and then donated $5,000 to the Art Center, he would have to claim the distribution as gross income on Page 1 of his Form 1040 and claim a charitable deduction on Schedule A. The $4,263 distribution would increase his Adjusted Gross Income (AGI) and could, as a result, increase the taxable portion of his Social Security or Railroad Retirement benefits by as much as $3,624, reduce his medical and miscellaneous itemized deductions by up to $405 and reduce or eliminate a number of other deductions and credits that are affected by AGI.

Now the $5,000 IRA transfer is tax-free and does not increase his AGI. Plus the additional $737 represents a tax-free withdrawal from his IRA.

Many retired taxpayers who must take required minimum distributions from an IRA are not able to itemize, due to the additional standard deduction for age 65 or older and the fact that their mortgage is paid off, and therefore get no, or only partial, tax benefit from their charitable contributions. By using a direct transfer to the charity of their choice to satisfy their annual required minimum distribution they will be able to get the full tax benefit for their contribution.

Charitable transfers should only be made from a "traditional" IRA. Because qualified distributions from a ROTH IRA are totally tax-free both to the owner as well as his or her beneficiaries there is no tax benefit in a direct transfer of funds from a Roth IRA to a charity.

In such a case it would be "more better" to take a distribution from the ROTH and make a cash contribution to the charity. The Roth distribution is not included in taxable income, and the contribution can be claimed as a deduction on Schedule A.

Qualifying taxpayers may also want to consider making a direct transfer from a traditional IRA to a charity now, instead of having a cash bequest made from their estate. As beneficiaries will be taxed on monies received from an inherited traditional IRA, by making the contributions as a direct transfer now one will -

  • reduce the tax cost to the beneficiaries of their inheritance,
  • reduce the balance in the traditional IRA, which will in turn reduce taxable required minimum distributions,
  • get the money to the charity sooner,
  • enjoy the appreciation of the charity during one's lifetime, and
  • see how the contribution is put to use.

The direct tax-free transfer to a charity is not available from SEPs or SIMPLE IRAs.

This temporary tax benefit is scheduled to expire on December 31, 2013.

Speaking of charitable contributions, instead of giving cash to charity at year-end you can donate stock, bonds or mutual fund shares that you have held for more than one year and which have increased in value, and save some money in the process.

You are able to claim a deduction for the full market price of the investment on the date you make the contribution. You do not have to report the increase in value as a capital gain on Schedule D.

If Mosynary from above was not required to take a RMD from an IRA account, he has another option for satisfying his $5,000 pledge. Mosynary has 100 shares of Online Profits, Inc. which he purchased in 1998 for $2,000 and is now worth $5,000. He decides to give the stock to the Art Center to satisfy his pledge. Ely can deduct $5,000 on his Schedule A. But he does not have to pay tax on the $3,000 appreciation in the value of the stock.

If Mosynary was in the 25% or higher federal tax bracket and he were to sell the stock and give $5,000 cash to the Center, he would have to report the sale on Schedule D and pay $450 in federal tax, as well as state income tax, on the gain. Plus, the $3,000 gain would increase his AGI, which, as discussed above, could increase his taxable income or reduce or altogether wipe out a multitude of deductions and credits. As an added bonus, by donating the stock rather than selling it Art will save the broker's commission and other expenses of sale.

Mosynary could save taxes and costs even if the gain on the stock sale was taxed at the special 0% capital gain tax rate.

You must be sure that any investment you donate is long-term property - an investment that you have held for more than one year. If you donate stock that you held one year or less your tax deduction is limited to the cost basis, which in the example is $2,000.

Also, don't donate an investment that has gone down in value. It is better to sell the stock, claim the loss on Schedule D, and donate the cash to charity.

As usual, consult your tax professional before taking any action.

--Written by Robert D. Flach for MainStreet

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