Donation from IRA may cut your tax bill

Q: I turned 70 1/2 this year, so it is my first year I'm required to take a distribution from my IRA.

I've kept waiting for the stock market to turn around before taking money out, so I haven't withdrawn anything yet. I have also been waiting to make my pledge to my church for the same reason. I had planned to contribute appreciated stock. I'd like to contribute fewer shares when they are worth more, but that doesn't seem likely before year end.

A friend of mine said I could take advantage of an extension of a law, which would let me donate money directly from my IRA. I vaguely remember something about that, but because I turned 70 1/2 after the law expired, I didn't pay much attention.

Has this been extended? If so, is it worthwhile and how does it work?

A: Your friend is correct: The temporary opportunity for those IRA owners over age 70 1/2 to transfer up to $100,000 from their IRA directly to charity has been extended through the end of 2009. This is a provision tucked into the Emergency Economic Stabilization, Energy Improvement and Extension, and Tax Extenders and AMT Relief Acts of 2008 -- also fondly referred to as the 2008 Economic Stabilization Act.

If you plan to make a charitable contribution and haven't taken your required minimum distribution under IRA rules, this is a great opportunity because it may result in a lower tax bill.

If you take your required distribution and then contribute to charity, you are able to deduct that amount if you itemize, but the required distribution is included in your income. The additional income could result in higher taxes on Social Security and Medicare premiums and a loss of tax deductions, credits and other tax benefits.

As part of the Pension Protection Act signed into law on Aug. 17, 2006, eligible IRA owners could make a qualified charitable distribution. This provision was available only for tax years 2006 and 2007 but has now been extended.

The qualified charitable distribution must be a transfer directly from your IRA to the qualified charity. The qualified charitable distribution is excluded from your taxable income. If you take an IRA distribution and subsequently write a check to the charity, the distribution will be included in your taxable income even if the amounts distributed and donated are the same.

IRA owners who have attained age 70 1/2 are now permitted to make qualified charitable distributions of up to $100,000 both this year and next. If a taxpayer is married and each spouse has their own IRA, each can contribute up to $100,000.

If you have a large amount of after-tax money in your IRA, you should definitely consider making qualified charitable distributions. The entire amount counts toward fulfilling your required minimum distribution. Normally, when you take a distribution from an IRA containing both after-tax and pre-tax contributions, the withdrawal will be part taxable and part an untaxed return on your investment.

All qualified charitable distributions will come from pre-tax contributions; this will reduce the pre-tax portion of the money in your IRA and increase the after-tax portion, which will reduce taxes owed on future distributions. This will also reduce taxes owed if you decide to convert all or part of your IRA to a Roth IRA.

Required minimum distributions already taken this year cannot be put back in your IRA, and they will be recognized as taxable income regardless of any qualified charitable distribution made in the remainder of 2008.

When making a qualified charitable distribution, verify that your IRA custodian will identify you by name and address when he or she sends the check to the charity. You will want an acknowledgement letter from the charity to confirm the contribution.

Check with the charity to make sure they qualify for this new tax benefit. Donor-advised funds, non-operating private foundations, supporting organizations, and any planned giving strategies that offer some type of benefit to the donor (charitable remainder trusts, gift annuities, etc.) do not qualify for this qualified charitable distribution strategy.