There is still time to adjust your year-end tax strategy and integrate a meaningful charitable giving strategy. Thanks to the Tax Relief, Unemployment Insurance Reauthorization and Job Creation Act of 2010 signed into law earlier this month, tax rates won’t be going up on January 1, 2011.
Roth IRA Conversions
Perhaps the greatest opportunity to adjust your year-end tax strategy in light of the new legislation involves Roth IRA conversions. Starting in 2010, all IRA owners, regardless of income, could convert their traditional IRA to a Roth IRA. Of course, the account owner is required to pay income tax on any pre-tax dollars converted to a Roth IRA. Coming up with the cash to pay for this large, one-time tax bill is a big deterrent for most investors.
Now that we know tax rates will not be going up after 2010, converting an IRA next year and in 2012 makes better tax sense than converting an IRA at the end of 2010. The rationale is the amount of time one has to change their mind after the Roth conversion. The Roth conversion rules state that an individual has up to October 15, 2012, to change their mind and recharacterize their Roth IRA. If the individual converted at the end of 2010, the time to change their mind extends to October 17, 2011. By waiting less than a week to convert to Roth after January 1, 2011, one can extend the “free look” by an additional 12 months.
Charitable IRA Rollover
For charitably inclined individuals 70 ½ and older can now make direct IRA Required Minimum Distribution (NYSE:RMD) transfers of up to $100,000 directly to charities for 2010 and 2011 without realizing taxable income. Previously this unique opportunity was in effect for the tax year 2009 but this provision expired at the end of 2009. Due to the popularity of this tax planning strategy for both individuals and the need for donations to non-profits, Congress and the President extended it for the next two years.
For those who have not taken their Required Minimum Distributions for 2010 and wish to give it to charity in 2010, Congress has extended the deadline to make a donation through January 31, 2011. However, if the distribution is not given to charity, the RMD must be taken by the individual by December 31.
In 2011, those over 70 ½ can give their IRA directly to charity. Although the donor will not receive a charitable income tax deduction, there are many advantages to consider giving from the IRA. By making a Qualified Charitable Distribution (QCD) directly to charity, the taxpayer will not pick up the distribution as taxable income thereby avoiding increasing their Adjusted Gross Income (NYSE:AGI). By having a lesser AGI, the taxpayer might pay less tax on Social Security Benefits or be able to deduct a greater portion of their Schedule A Medical Expenses and Miscellaneous Deductions subject to phase outs based upon one’s Adjusted Gross Income.
However, if an eligible individual has the capacity to make a QCD and owns low basis securities, it is advisable that careful analysis be given as to which asset to give to charity.