Tax Cuts for Charity, 2011

There’s no doubt about it: the current tax laws are pretty confusing for most of us. While some people were quick to call the President a sell-out when he allowed Republicans to preserve tax cuts for the wealthy last year, the fact that he did it in an effort to form a deal that would extend unemployment benefits makes it understandable. But how were the Republicans able to pull it off? Can tax law be so easily changed? Actually, yes. Our current tax laws are in the midst of rotation. Tax breaks that were enacted a few years ago in an effort to bolster the economy were set to phase out within a few years (as evidenced by tax cuts for the wealthy, before they were extended). And one of the many breaks that were given went to elderly citizens who wished to donate a portion of their IRA income to charity. But will that tax break continue this year? Absolutely.

To understand how it works, you first need to understand how an IRA works. You put money in before you retire, up to a certain amount each year. As you continue to add to your account, it also gains interest. The nice thing about an IRA is, you get to put money in pre-taxation (deducting it from your annual income), so that you are able to save as much as possible (and earn as much interest) before you retire. Then, when you reach retirement age, you begin to receive a disbursement from your IRA in set increments each year, which is taxed as income. What most people don’t count on is how much money they can accumulate in such an account. By the time they retire, they could be getting a large enough disbursement that it sends them right into the next tax bracket, completely messing up their finances.

So what current tax law allows is for charitable contributions directly from the IRA disbursement. Elderly individuals who don’t wish to pay so much in taxes can instead donate up to $100,000 annually, pre-tax, from their IRA. Since this money is not viewed as income, it doesn’t need to be listed on taxes, nor is it required to be cited as a deduction (allowing those who do it to avoid dealing with paperwork and caps). It should be noted that although this portion of tax law is set to phase out after 2012, the section pertaining to itemized deductions was done away with in 2010, making such donations subject to a cap. So this is pretty much the only option left for making charitable donations tax-free.

While many elderly might rather have the extra $100,000, despite taxation, the law probably pertains more to those who are getting just a few thousand dollars too much (thus pushing them into a higher tax bracket without giving them any added benefit). If you find yourself in this unfortunate situation, you have at least the next two years to take advantage of the tax break provided for charitable contributions from your IRA.

Sarah Danielson writes for Roth IRA where you can read over rules for Roth IRAs and learn about converting IRA to Roth as well as finding other tools and information to help you on the road to retirement.