Make Charitable Contributions Count

Each year, roughly one-third of American households itemize deductions on their federal income taxes. If you’re among that group, there are several important actions you need to take by year’s end to take full advantage of available deductions.

For example, by Dec. 31 you must pay for any uninsured medical expenses, state and local income and property taxes, and unreimbursed employee expenses you want to deduct from your 2011 taxes. You also need to decide how much to contribute to charitable organizations and either charge your credit/debit card or postmark a check by midnight on the final day of the year.

Here are a few issues to keep in mind when choosing how you’ll make – and report – your charitable contributions.

Confirm the organization’s tax-exempt status. The IRS revoked the tax-exempt status of approximately 275,000 nonprofit organizations because they hadn’t filed annual reports for three consecutive years, as required by law. Although donations you may have made to those organizations prior to their being disqualified still count as tax deductible, going forward such organizations are no longer eligible to receive tax-deductible contributions unless they’re reinstated by the IRS. Go to www.irs.gov/charities to see if your donations are affected.

Charitable auction purchases and donations. If you buy an item at a charitable auction, you’re only allowed to claim a deduction for the amount you pay that’s above its fair market value, so be sure to get documentation from the organization (e.g., a catalog showing a good-faith estimate). On the other hand, if you donate an item for a charitable auction, you’re only allowed to claim your “tax basis” in the item – that is, the amount you originally paid for it rather than its current fair market value.

IRA distributions. For many, one of our tax code’s downfalls is that unless you itemize deductions you cannot reap tax advantages from your charitable contributions. However, an important exception is made for senior citizens, many of whom no longer carry a mortgage and thus don’t itemize deductions: People age 70½ or older may contribute up to $100,000 from their IRAs directly to charity and have it count toward their 2011 required minimum distribution (RMD). Although the RMD contribution itself isn’t tax deductible, the amount won’t be included in your adjusted gross income (AGI), thereby providing several potential tax benefits:

• A lower AGI could reduce taxes on your Social Security benefits.

• It could make you eligible for tax breaks that are tied to AGI.

• The contribution will lower your overall IRA balance, which in turn reduces the size of future mandatory distributions.

Choose wisely. Before making a donation or volunteering your time, make sure the nonprofit organization is well run. Ideally the organization applies at least 75 percent of contributions to programs that serve its beneficiaries, as opposed to spending them on salaries, advertising, fundraising and other administrative expenses.

The IRS’ Tax Information for Contributors website (www.irs.gov/charities/contributors) features a search engine for eligible organizations, information on reporting and substantiating charitable deductions, and other helpful tips. Also, GuideStar’s website (www2.guidestar.org) features helpful questions to ask potential recipients and tips for choosing a charity.

The personal rewards that come from donating your time and money to worthy causes certainly far exceed mere tax breaks, but it still pays to know how the rules work in case you do qualify.

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Mandatory IRA Withdrawals

Reaching your 70th birthday is cause for celebration. But thanks to our quirky tax code, a potentially more important milestone arrives six months later. IRS rules say that you must begin taking required minimum distributions (RMDs) from your IRAs and other tax-deferred retirement accounts beginning in the year you reach age 70 1/2.

Failure to make these mandatory withdrawals by Dec. 31 each year can result in severe penalties, so if you or someone you know is approaching that threshold, read on:

Congress devised IRAs, 401(k) plans and other tax-deferred retirement accounts to encourage people to save for their own retirement. You generally contribute pretax dollars to these accounts (except for Roth plans), which means the money and its investment earnings are not subject to income tax until withdrawal.

In return, Congress decreed that RMDs must be withdrawn – and taxed – each year after you reach 70 1/2. If you don’t (unless you meet certain narrow conditions), you’ll have to pay an excess accumulation tax equal to 50 percent of the RMD you should have taken – plus take the distribution and pay taxes on it.

In a few cases you can delay or avoid taking an RMD:

• If still employed at 70 1/2, you may delay RMDs from your 401(k) or other work-based account until you actually retire, without penalty; however, regular IRAs are subject to the rule, regardless of work status.

• Roth IRAs are exempt from the RMD rule; however Roth 401(k) plans are not.

• As discussed above, you can also transfer up to $100,000 directly from your IRA to an IRS-approved charity. Although the RMD charitable transfer itself isn’t tax deductible, it won’t be included in your taxable income and lowers your overall IRA balance, thus reducing the size of future RMDs.

Another way to circumvent the RMD is to convert your tax-deferred accounts into a Roth IRA. You’ll still have to pay taxes on pretax contributions and earnings; and, if you’re over age 70 1/2, you must first take your minimum distribution (and pay taxes on it) before the conversion can take place.

Ordinarily, RMDs must be taken by Dec. 31 to avoid the penalty. However, if it’s your first distribution you may wait until April 1 the year after turning 70 1/2 – although you still must take a second distribution by Dec. 31 that same year. Generally, you must calculate an RMD for each IRA or other tax-deferred retirement account you own by dividing its balance at the end of the previous year by a life expectancy factor found in one of the three tables in Appendix C of IRS Publication 590:

• Use the Uniform Lifetime Table if your spouse isn’t more than 10 years younger than you, your spouse isn’t the sole beneficiary, or you’re single.

• Use the Joint and Last Survivor Table when your spouse is the sole beneficiary and he/she is more than 10 years younger than you.

• The Single Life Expectancy Table is for beneficiaries of accounts whose owner has died.

Although you must calculate the RMD separately for each IRA you own, you may withdraw the combined amount from one or more of them. The same goes for owners of one or more 403(b) accounts. However, RMDs required from 401(k) or 457(b) plans must be taken separately from each account.

To learn more about RMDs, read IRS Publication 590 at www.irs.gov.