Despite the downturn, many of your retired clients may want to make charitable donations. The so-called IRA charitable rollover has been called a no-brainer for seniors' philanthropy by Natalie Choate, an attorney with Nutter McClennen & Fish in Boston.

This tax code innovation was created in 2006, expired after 2007 and was extended through 2009 in the first bailout bill in October 2008. Two months later, the Worker, Retiree, and Employer Recovery Act suspended required minimum distributions (RMDs) from IRAs in 2009. The net result: A no-brainer has become a puzzler. "If the choice is between using a qualified charitable distribution (QCD) or funding the gift out of current income to get a tax deduction, I'm not sure there's an easy answer," says Choate, author of Life and Death Planning for Retirement Benefits.

Donation Dilemma

Assume Jim Jones, 58, retired and rolled a large sum from his 401(k) into an IRA. Jim wants to donate to charity using money from his IRA. To do so, Jim must withdraw money from his IRA first, then write a check to charity. This should be a wash: If Jim picks up $50,000 of income from an IRA distribution, he'll also get a $50,000 tax deduction when he donates that amount to charity.

But Jim won't enjoy such a neat outcome. Since he's not yet 591/2, he'll owe a 10% early withdrawal penalty on the IRA distribution. If he is in a 28% tax bracket, he may pay a total of 38% tax on the withdrawal, yet get only a 28% deduction for the donation. Moreover, the tax code limits the charitable contributions an individual can deduct each year. Deductions for cash donations are generally capped at 50% of adjusted gross income (AGI), which could be a concern for retirees. But regardless of whether it's a concern, clients who take money from their IRA to fund donations will increase their AGI by the amount of the distribution. A higher AGI may reduce their ability to use tax benefits such as deductions for medical bills.

Elder Shelter

To address these tax concerns, the Pension Protection Act of 2006 introduced IRA charitable rollovers, permitting eligible IRA owners to transfer up to $100,000 a year from their IRA directly to charity without recognizing the transfer as income and, therefore, without taking a deduction. The IRA charitable rollover is limited to people over age 701/2. Not coincidentally, that's the age when IRA owners must start taking RMDs from their IRAs; they face a 50% penalty for insufficient withdrawals.

When the charitable-rollover provision began, Choate says, taking QCDs became a no-brainer for philanthropic taxpayers who must take RMDs. For example, Alice Smith, 75, must take $50,000 a year from her IRA and wants to donate $50,000 to charity. Implementing a $50,000 charitable rollover meets her RMD obligation and fulfills her charitable goals without exceeding deduction caps or swelling her AGI. She may enjoy a second tax benefit too. "A QCD comes first from the owner's pretax money in all her aggregated IRAs, until that's been used up," Choate says. Making a QCD raises the proportion of after-tax dollars left in the client's IRA (such as nondeductible contributions), so she'll owe less tax on subsequent non-charitable distributions.

Suspension Tension

With all these advantages, eligible clients benefitted if they used QCDs in 2006, 2007 and 2008. But this year is different. The 50% penalty on insufficient IRA distributions has been suspended for 2009, so there's no need to move money out of an IRA. Should clients use the IRA charitable rollover anyway?

Clients who view a QCD mainly as a way to mitigate the tax burden of RMDs and don't need to take IRA distributions in 2009 should skip the QCD this year, Choate says. On the other hand, "Some clients tend to use their IRAs to fund charitable pledges rather than take money from after-tax accounts," says Roger Lusby, tax partner at accounting firm Frazier & Deeter in Atlanta. "It makes them feel more comfortable, since it's 'not their funds' they're giving away, but money that partially belongs to the IRS. Many clients think it's good to have another pocket to tap for donations."

Marty James, head of an accounting and investment advisory firm in Mooresville, Ind., says clients who take the standard deduction on their tax return rather than itemize deductions get no tax benefit from charitable contributions. With no deduction, clients may as well take money from their IRA, tax-free, when donating. "A QCD isn't taxable and is fully deductible," says Blanche Lark Christerson, managing director of Deutsche Bank Private Wealth Management in New York City.