|
 |
What's in it for me?
That's the question millions
of taxpayers are asking...
Key Issue 26I: Making a Tax-free IRA Distribution to Charity
A favorable provision in the 2006 Pension Protection Act of 2006
(2006 Pension Act) permits an individual who has reached age
70 1/2 to arrange to distribute otherwise taxable
traditional and Roth IRA amounts directly to certain
tax-exempt charities. These distributions are called
qualified charitable distributions. They are federal income
tax-free to the donor. No charitable deduction is allowed on
Form 1040. Even so, qualified charitable distributions can
have valuable tax-saving advantages, as explained later in
this
key
issue.
The new qualified charitable distribution provision is only
available for distributions during 2006 and 2007. No more
than $100,000 can be donated under the new rule in either of
those years (i.e., up to $100,000 per year, for both 2006
and 2007).
Qualified charitable distributions are payments of
otherwise taxable amounts by an IRA trustee directly to a
qualified public charity (generally, so-called 50%
charities, with some exceptions). The new rule cannot be
used for distributions from SEP accounts, SIMPLE accounts,
or qualified retirement plan accounts. [See
IRC Sec.
408(d)
, as amended by the 2006 Pension Act.]
Observation:
Under the pre-2006 Pension Act rules (which will reappear after
2007 unless Congress takes further action), a person who
wanted to donate money from an IRA had to take a withdrawal
from the account, include the taxable amount of the
withdrawal in gross income, donate the cash to charity, and
claim an itemized charitable donation deduction.
Equivalent to Immediate 100% Deduction with No
Adverse Side Effects
Tax-free treatment for a qualified charitable distribution
equates to an immediate 100% above-the-line deduction
without any effect on the 50%-of-AGI limitation on cash
contributions to 50% charities or the itemized deduction
phase-out rule for these distributions.
Also, the fact that qualified charitable distributions are
not included in the donor's AGI lowers the odds that he or
she will be affected by various other unfavorable AGI-based
tax provisions, such as the phase-out rule for the $25,000
rental real estate exception to the passive loss rules.
Impact on Minimum Required Distributions
A qualified charitable distribution counts as a distribution
for purposes of the minimum required distribution (MRD)
rules explained in
Key
Issue
5J
. (See the Joint Committee on Taxation's Technical
Explanation of Section 1201 of the 2006 Pension Act.)
Therefore, wealthier individuals can arrange to simply
donate amounts that they would otherwise be required to
receive (and pay tax on) under the MRD rules.
Distribution Ordering Rules
If the donor owns one or more IRAs to which nondeductible
contributions have been made, the taxable amounts are
treated as distributed first for qualified charitable
distribution purposes. All of the taxpayer's traditional
IRAs are aggregated for this purpose. This is contrary to
the "normal rules" under which all traditional IRA
distributions are treated as partly taxable and partly a
tax-free return of basis.
Apparently, all the taxpayer's Roth IRAs are also
separately aggregated for this purpose. Roth distributions
can be taxable if they are not qualified distributions.
However, since qualified Roth IRA distributions can be
received by the account owner or his or her heirs, the idea
of making qualified charitable distributions out of Roth
accounts is generally not nearly as attractive as making
such distributions out of traditional IRAs.
Warning:
Tax-free qualified charitable distribution treatment only applies
when the entire amount that is distributed would otherwise
be deductible under
IRC Sec.
170
. Therefore, if the donor receives any benefit from the
charity that would reduce the donor's deduction under the
normal Section 170 rules, tax-free treatment does not apply
to the entire distribution.
Best Candidates for Qualified Charitable
Distributions
The new qualified charitable contribution privilege is most
beneficial for wealthier seniors who (1) do not itemize, (2)
would be adversely affected by limitations on itemized
charitable deductions, (3) want to avoid being taxed on MRDs
received from their traditional IRAs, or (4) are interested
in reducing their taxable estates in a quick and easy
fashion.
Example 26I-1: Tax results from making a qualified
charitable distribution.
Patsy, age 72, is financially comfortable and does not need
her IRA money to finance her retirement. She has $135,000 in
traditional IRA 1 and another $110,000 in traditional IRA 2
(total of $245,000). Over the years, Patsy made $40,000 in
nondeductible contributions to IRA 1.
In December of 2006, Patsy makes a qualified charitable
distribution of $100,000 out of IRA 1, leaving a balance of
$35,000 in that account. The distribution is treating as
coming out of the taxable portion of Patsy's IRAs.
Therefore, after the distribution, her remaining IRA
balances total $145,000 ($35,000 in IRA 1 and $110,000 in
IRA 2). Of the $145,000 amount, $105,000 is taxable money
and $40,000 is nontaxable money (the entire amount of her
nondeductible contributions).
The $100,000 qualified charitable distribution for 2006 is
more than enough to fulfill Patsy's annual MRD obligation
with respect to her IRAs,
but she owes no federal income tax. In effect, the qualified
charitable distribution is the same as an immediate $100,000
above-the-line deduction.
In addition, Patsy's MRDs for post-2006 years will be
significantly lower because her IRA balances have been
reduced by $100,000.
Also, Patsy still has the entire $40,000 of nontaxable money
in her IRAs, which she or her heirs can withdraw tax-free in
the future.
Finally, the qualified charitable distribution reduces
Patsy's taxable estate by $100,000.
VARIATION
If Patsy makes her $100,000 qualified charitable :
distribution out of IRA 2, the tax results would be exactly
the same. The only difference would be $100,000 less in IRA
2 and $100,000 more in IRA 1.
Reporting the Distribution
The total qualified charitable distribution is included on line 15a
of the 2006 Form 1040 and a -0- (zero) entered on line 15b.
The designation "QCD" should be entered next to line 15b.
|
Construction companies qualify for
deduction on work Done in America
U.S. taxpayers can immediately take a 3% tax deduction for U.S.-based
business activities.
by
Rizvana Zameeruddin
(original article online)
Despite its complexity, IRC section 199
provides significant and immediate tax
relief to many U.S. taxpayers. Section
199 is a tax deduction equal to 3% of
net income. Due to a broad
interpretation of what constitutes
“manufacturing,” if your clients are in
the manufacturing, retail or certain
service industries, they may be entitled
to take advantage of the qualified
production activities (QPA) tax
deduction.
American Jobs Creation Act of 2004 to
help grow U.S. manufacturing jobs. The
IRC section 199 qualified production
activities deduction replaces IRC
section 114, extraterritorial income
(ETI) exclusion.
OVERVIEW
OF THE
DEDUCTION
The qualified production
activities (QPA) deduction is available
to individuals, trusts and estates,
partnerships and other pass-through
entities such as S corporations and
limited liability companies who provide
certain services, or legally manufacture
or retail products in the United States.
For pass-through entities, the QPA
deduction’s rules are applied at the
shareholder or partner level, and for
affiliated groups, the test is
determined at the corporate-entity
level. The deduction is claimed on IRS
form 8903; CPAs should review form 8903,
consolidated roll-ups and schedule K-1
before preparing the client’s tax
return.
Unlike the extraterritorial income (ETI)
deduction, the qualified production
activities (QPA) deduction does not
mandate that taxpayers export their
product to qualify. Many products and
services produced and performed in the
United States qualify for the QPA
deduction, including film, sound
recordings,
construction, engineering services, architectural
services and computer software.
CALCULATING
THE
DEDUCTION
Depending on the nature of your client’s
business, computing the deduction can be
either very straightforward or extremely
involved. To accurately calculate the
deduction, CPAs must look closely at the
qualified production activities income (QPAI)
and the limitations. The deduction
percentage is 3% for tax years 2005 to
2006.
The deduction increases to 6% for tax
years 2007 to 2009, and maximizes
at 9% for tax year 2010 and after.
The deduction is calculated by taking
the lesser of the taxpayer’s QPAI or
taxable income, multiplying it by the
phased-in deduction percentage, which
ranges from 3% to 9%, and then applying
the W-2 wage cap, which is 50% of wages
paid. QPAI is determined by reducing the
domestically produced gross receipts
(DPGR) by the cost of goods sold
allocable to DPGR, other deductions and
expenses directly allocable to DPGR, and
a ratable portion of other expenses
indirectly allocable to DPGR. For
purposes of applying the W-2 wage
limitation, an owner’s share of
allocated QPAI also is treated as the
owner’s share of W-2 wages from the
pass-through entity. The following chart
provides the maximum qualified
production activities (QPA) deduction
percentage permitted between tax years
2005 and 2010.
|
Tax year
|
Deduction |
Corporate tax rate |
|
2005–2006 |
3% |
33.95% |
|
2007–2009
|
6% |
32.90% |
|
2010 and after
|
9% |
31.85% |
|
|
 In order
to maximize the
Qualified
Production
Activities
deduction, use
time-saving
technologies to
keep track of
Domestically
Produced Gross
Receipts and
related
expenses. |
|
FINAL
THOUGHT
Although section 199’s allocation
requirements seem cumbersome, the vast
benefits of the deduction may be reaped
immediately. The regulations provide
much-needed clarification of the
simplified methods and safe harbors
under notice 2005-14. Although the
administrative burden of allocating
qualified production property gross
receipts between domestically produced
gross receipts (DPGR) and non-DPGR may
seem vast for smaller taxpayers, the
simplified allocation methods make the
potential benefit worth the extra costs.
Larger taxpayers, despite having to use
the cumbersome section 861 regulations
for allocation, also may see immediate
benefits.
Taxpayers who manufacture qualified
production property in the United States
and assemble the finished product
overseas may be especially surprised to
find that the section 199 deduction is
much greater than they originally had
anticipated.  |
|
|
|
Facts
On March 31,
2005, Park Construction Co.
paid $700,000 for each of
two tracts of land on which
it plans to build two houses
at a cost of $350,000 each.
In 2007 Park pays $500,000
in entitlement costs and
begins construction. It also
pays $500,000 per lot in
common improvements,
including $40,000 per lot in
land costs. In 2009 it sells
the first of the two homes
for $1 million.
Construction—Land Safe
Harbor
Land
costs include zoning,
planning, and other costs
associated with demolition.
The safe harbor rule
provides that gross receipts
from the sale of real
property are allocated by
reducing domestically
produced gross receipts
(DPGR) by land costs, and a
percentage based on the land
holding period. In this
example since the land is
held for fewer than five
years, DPGR are reduced by
5%.
|
Year |
Percentage |
|
0–5 |
5% |
|
6–10 |
10% |
|
11–15 |
15% |
|
16+ |
Not eligible for
safe harbor |
|
Construction |
$350,000 |
|
Common improvements |
$100,000 |
|
Land cost |
$350,000 |
|
Equals |
$800,000 |
|
Less land costs |
($390,000) |
|
Tract plus land costs |
$410,000 |
DPGR
|
Receipts |
$1,000,000 |
|
Less land costs |
($390,000) |
|
Less 5% of land costs |
($19,500) |
|
Equals DGR |
$590,500 |
|
QPAI (Costs minus DPGR) |
$180,500 |
Calculation of deduction
|
QPAI |
$180,500 X 6% |
|
Deduction |
$10,830 |
|
|
(original article online) |
|
|
