Your client's individual retirement account (IRA) may be the largest asset they hold upon his or her death. Experts say more than $18 trillion of accumulated wealth is currently held in IRAs. IRA planning, particularly the interplay between tax and estate planning benefits, is complicated but critical to ensure the best income tax and estate tax result.

The Pension Protection Act of 2006, which was signed into law on August 17, 2006 (see The Pension Protection Act of 2006 in today's issue), provides an additional method for income and estate tax savings through the use of charitable gifts. The applicable provisions, in summary, provide that a person over the age of 70½ may make a charitable gift directly from his or her IRA of up to $100,000 per year (in years 2006 and 2007) without having to report the distribution as taxable income.

First, it is important to note that the new rules apply only to outright lifetime transfers from IRA owners. The rules and benefits applicable to testamentary transfers remain unchanged.

In a nutshell, the new law provides an exclusion from gross income for otherwise taxable IRA distributions of up to $100,000 per year from traditional IRAs and Roth IRAs for "qualified charitable distributions" made during 2006 and 2007 by plan owners who have attained at least age 70½ on the date of distribution to charity.

The Key Benefits

1. Distributions to charity satisfy the minimum distribution requirements. Therefore, if your clients are required to distribute $200,000 in 2006 and make a $100,000 distribution to charity, they will only have to distribute and report as taxable income $100,000 for 2006.
   
2. Because the distribution is not reported as taxable income, the charitable gift is not subject to the phase-out of itemized deductions and donors do not have to itemize, to receive the tax benefits.
   
3. Social security recipients will be benefited if (excluding the IRA distribution) they keep their taxable income below thresholds that cause social security benefits to be subject to tax.
   
4. There are no percentage limitations so that if your clients already make gifts of 50 percent of adjusted gross income, this direct distribution to charity will not count against the 50 percent limit.

Frequently Asked Questions

Can my client make a distribution directly from her 401(k) plan?

This only applies to IRAs. 401(k), 403(b) annuities, defined benefit and contribution plans, profit-sharing plans, Keoghs and employer-sponsored SEPs and SIMPLE plans are not eligible. This is one reason that some clients might find it makes sense to roll over a 401(k) plan into a qualifying IRA.

Can my client make a $100,000 distribution in 2006 and then again in 2007?

Yes, clients can make a maximum of $100,000 in distributions to charity from an IRA in 2006 and again in 2007 without reporting taxable income.

What if my client doesn't turn 70½ until the end of 2006?

The distribution cannot be made until your client is 70½. For example, if your client reaches age 70½ on December 31, 2006, in order to reap the benefits for the year 2006, the distribution from the IRA will have to take place that day. It is important to distinguish this rule from the rule that requires plan participants to begin receiving minimum required distributions in the same year they reach 70½ (if they have already begun receiving distributions) and no later than April 1st of the year following the year in which they attain age 70½ (if they have not).

My client has a donor-advised fund. Can he or she make the distribution to that fund?

No, the distribution must be to a public charity or private operating foundation. Donor-advised funds and supporting organizations will not qualify.

The IRA custodian doesn't want to make a number of small gifts to charity from my client's IRA. Can she distribute the funds to herself and then write checks to the individual charities?

The distribution must pass directly from the IRA to the charity. If a distribution is made to your client and then your client writes the check to the charity, your client will have to report the distribution as taxable income and then take a charitable deduction subject to the usual limitations. IRA custodians will presumably be coming up with different ways to deal with the administrative burdens of this new law. It is also imperative that the charity provide a written receipt for the contribution. One way to make sure that the charity processes the contribution properly, would be for the client to receive the check from the IRA administrator already made out to the charity, and then the IRA owner can send the check directly and ask for an acknowledgement of the gift.

This new law is beneficial to both clients and charities. And although it does not apply to testamentary gifts, any distribution to charity reduces your client's taxable estate at death. That is a win-win situation for everyone.