Blogging Employee Benefits

August 30, 2006

PPA: QCDs from IRAs

Filed under: IRA — Fuguerre @ 7:01 pm

Among the scores of complicated provisions of the Pension Protection Act of 2006, charitable contributions may be made directly from an individual retirement account through a qualified charitable distribution (QCD). [PPA §1201; JCX-38-06 technical explanation] Amounts properly transferred from an IRA via a QCD are not included in the individual’s taxable income; conversely, then, a QCD cannot be included among itemized deductions.

OK, hold on a minute, where’s the beef? If the individual receives a taxable distribution from an IRA and during the same taxable year donates the full pre-tax amount relating to that distribution to the charity, doesn’t that achieve the same result? Well, sort of: for the typical charity-giving taxpayer, this PPA provision offers little if anything. Aside from the charities themselves, who have lobbied for something along these lines for the better part of the past decade, the main beneficiaries of this rule will be –

  • Taxpayers Who Use the Standard Deduction – To achieve similar results under pre-PPA law, the taxpayer would have had to itemize deductions. With a QCD, the taxpayer has no taxable income attributable to the transfer from the IRA, yet can still use the standard deduction. In practice, we’re probably talking relatively small charitable contribution amounts here, since folk regularly relying on the standard deduction aren’t generally known for being generous benefactors, and since we get back to the where’s-the-beef scenario with a QCD amount that (together with other deductible amounts) would be high enough to make the standard deduction less valuable than itemizing. Remember that small-amount prognosis when I turn my attention from where’s-the-beef to where’s-my-trustee.
  • Very Generous Benefactors – QCDs don’t count against the limits on charitable contributions. So a taxpayer with huge past charitable donations at risk of being lost to the 5-year carryover period or donors interested in making a huge one-time charitable contribution can essentially use a QCD to draw down the carryover or extend the charitable contribution limits. Nice, but let’s take a nose count here: exactly how rare are such generous souls? Each QCD by a member of this set could be relatively large – “relatively” there meaning we’re not talking Warren Buffett large, at least not through any QCD, given dollar limits I’ll touch on in a minute – but will there really be enough of these donors to justify Congress’ budget estimates projected for this PPA provision?
  • Recent Converts to Roth IRAs Who Now Want Out – To be exempt from income tax, a qualified distribution from a Roth IRA must be made after the close of the 5th taxable year during which the individual first established any Roth IRA. If an individual established a Roth IRA more recently than 5 years ago, but now wants out and would be otherwise making charitable contributions anyway, then a QCD from the Roth IRA might make a reasonable exit door, as long as the individual can forget that taxes were paid on the front end of the Roth. Is it obvious I’ve arranged these three sets in descending order ranked by my speculation of how many individuals might actually attempt a QCD?
  • Those Who Simply Hate Withholding – Continuing that ranking to what will be the smallest group of the already tiny herd, the itemizer who is not hitting any charitable contribution limits and doesn’t have a new Roth IRA might still cast an eye at a QCD, if just to avoid the withholding on the benchmark transaction.

Not yet convinced that we’re talking of a headcount that probably wouldn’t fill a high school auditorium? Then let’s add a critical requirement that has escaped the notice of some (my fave being one tax professional’s write-up, which claims that a QCD offers a way to “avoid the penalty on early withdrawals”): a QCD may only be made after the taxpayer has reached age 70½ (which obviously is more than a decade beyond the reach of §72(t)). As familiar at this age threshold might feel vis a vis §401(a)(9) via §408(a)(6), don’t let the distinction drawn by this new rule escape notice: for the minimum distribution requirement, we look to April 1 of the year following the year of attainment of age 70½; in contrast, a QCD may be made as soon as the individual is age 70½. But back to the theme of how rare QCDs are likely to be: aside from the unlikelihood that it will become common for fresh septuagenarians to start celebrating their first half-birthday with a QCD, we’re already starting out with a small slice of the IRA universe by restricting QCDs to those over 70½.

And as long as I’m shrinking the QCD phenom down to a pinprick, let’s briefly summarize a few of the other QCD conditions. For one thing, the benchmark donor (normal IRA distribution taken into taxable income, followed by a donation that is itemized) can receive something back from the charitable organization and still get a deduction for the excess of the contribution over the value of the quid pro quo benefit. In contrast, if the taxpayer receives anything of value back from the charitable organization for the attempted QCD, then the entire amount is ineligible for QCD tax treatment. In terms of income taxes and deductions, the worst that might mean is a return to the benchmark, although the JCX-38-06 explanation only mentions that the income exclusion is lost, remaining silent on what ought to be the obvious followthrough that the individual ought then be able to return to the usual itemized deduction route. Even so, it’s not inconceivable that there might be some nuisance issues relating to withholding not having been done on the attempted QCD, among other possible headaches. The practical lesson being: if you have enough courage to try to navigate QCD waters, don’t accept that coffee mug thank-you with the charity’s name on it. And the shrinking aspect of this being that donors who really do want that coffee mug (or more to the point, any of the pricier items offered by charities as enticements for larger donations) aren’t going to want a QCD, while those who overlook the no-gift rule risk being downsized by the IRS out of Congress’ QCD budget projections.

More shrinking tonic: QCDs may not be made to donor-advised funds or supporting organizations, even those maintained by an otherwise acceptable charitable organization. Nor may QCDs be made in exchange for a charitable gift annuity nor to a split-interest charitable trust. Suffice it here to say we’re shaving down the Very Generous Benefactor set, unless we might hope for new charitable contributions to be made above and beyond what would have been directed to those organizations or handled through those means.

I’ve alluded to Congress’ budget estimates several times here; let’s go there for another comment or two. I’m looking at both the Joint Committee on Taxation’s Estimated Budget Effects and the Congressional Budget Office’s Cost Estimate. The picture gets clouded up by PPA’s curious (very heavy euphemism there) pairing of the QCD provision with new filing requirements for split-interest trusts [PPA §1201(b)], both of which are then combined and offset for the §1201 line item in the budget estimate. Help me out here, I confess to serious confusion here: how do new penalties on a split-interest trust’s failure to file a return poke a hole in the federal treasury? Because if we instead call the revenue effect of the split-interest trust filing requirement relatively negligible, then call me skeptical that we get enough out of the very very very rare QCDers to come close to a quarter of $1 billion for 2007 (meaning we’d need in the neighborhood of $1 billion of QCD for the year). Since the maximum annual QCD is $100,000, we’d need 10,000 generous IRA owners over age 70½ going for the max to reach that if all we had to work with were Very Generous Benefactors who care to forgo their donor-advised funds and gift annuities and quid pro quo benefits. And since the average QCD will most certainly be rather far south of the $100,000 ceiling, somewhere the budget estimators are seeing legions of superannuated donors lining up for the new alternative to the benchmark income/deduction route.

Not only that, but budget losses from the split-interest trust filing requirement needs to be enough so to offset positive numbers that ought be there for QCDs beyond the first budget year, since budget estimates continue to show negatives stretching out beyond 2007. Which one would think ought not be there, since the QCD provision sunsets at the end of next year. Meaning not only that we don’t have any remaining budget drain from the standard deduction QCDers, but that we ought be expecting some positive numbers for those who had essentially used the QCD to clear out accumulated carryover (since after all, the QCD for that set is not really a new permanent tax break, but more of the nature of accelerating the deduction).

And that end-of-2007 sunset finally bringing me to my search for the missing IRA trustee. QCDs may look so-so to my small set of elderly taxpayers who would find them advantageous, and certainly must look very promising to charitable organizations hungry for new donations above and beyond what otherwise would have been there, but PPA gives absolutely no incentives to the IRA trustee. Nor does PPA in any way whatsoever require that IRA trustees offer QCDs. All the IRA trustee sees is a rather complex tangle of new rules for which “further clarification” from Treasury is awaited, additional administrative and reporting burdens, in the case of the standard deduction group for the sake of donations that might be rather small amounts relative to the IRA trustee’s effort, for which in exchange the IRA trustee sees only the potential for accelerated disappearance of IRA funds, all for a trick that might have a lifespan no more than 16 months. Is it any wonder that we don’t see IRA trustees rushing to process QCDs, although the provision is already effective, available for use in 2006? “Call us back in November,” advises one of the top IRA providers, stating that no general announcement would be made if and when QCDs could ever be made from its IRAs due to the “cost and potential confusion” of individual IRA holders. Then as if to emphasize the “potential confusion” part of that equation, this particular IRA trustee advises its customer to remember that IRA funds could always simply be withdrawn by the IRA holder, then contributed by the individual to the charity, apparently either missing or simply not caring about the point: since anything passing through the individual’s hands won’t be a QCD, the taxpayer can expect taxes to be withheld on that withdrawal and a 1099 from the IRA trustee the following year. Which of course was not the goal of the exercise.

Without the IRA trustees on board, call this another noble cause that will sputter along through 2007, then be retired to the tax history museum unless the provision is extended to all IRA holders young and old, broadened to give it more weight beyond tweaking the nuances of charitable contribution tax policy, and polished up in some way that will encourage IRA trustees to actually implement it. Just one blogger’s opinion.

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