You may have philanthropic clients who are limited to the amount of charitable deduction they can claim due to how much income they report. They may also be interested in creating a tax-free retirement account for themselves or their heirs. Combining these two strategies may make sense.
Charitable contribution tax rules at a glance
The amount of charitable deduction a taxpayer can claim on his or her tax return generally depends on these two factors:
- The type of gift (e.g., cash, appreciated stock, tangible personal property)
- The type of charity (whether it benefits the general public or serves a limited purpose)
The maximum percentage of a charitable gift that can be deducted in any single tax year is 50% of adjusted gross income (AGI). This applies to public charities. If the gift is appreciated capital gain property and the amount of the gift is based on fair market value, the maximum percentage is 30%. The corresponding percentages for non-public charities are 30% of AGI for cash and 20% of AGI for capital gain property.
Example of using a Roth IRA conversion strategy
Let’s consider a hypothetical example to see how clients may benefit from a Roth IRA conversion in this situation.
| AGI | $250,000 | AGI including $100,000 Roth conversion | $350,000 | |
| Stock gifted to charity | 105,000 | Stock gifted to charity | 105,000 | |
| Maximum allowable deduction (30% of AGI) |
75,000 | Maximum allowable deduction (30% of AGI) |
105,000 | |
| Charitable carryover without Roth conversion | 30,000 | Charitable carryover with Roth conversion | 0 |
In the example, the client is gifting appreciated stock (capital gain property) to a public charity, resulting in a 30% deduction of AGI. Assuming no other charitable gifts in the year, the maximum deduction the client can claim on the tax form is 30% of AGI or $75,000. Since the amount of the charitable gift ($105,000) exceeds the amount of the maximum charitable deduction ($75,000) allowed for that year, the excess charitable deduction ($30,000) must be carried forward to future tax years. This can be done for a maximum of five years.
In this situation, a client interested in the benefits of a Roth IRA may want to consider a conversion to increase income and enable the entire amount of the charitable gift to be deducted on taxes during that year. This results in the elimination of the charitable deduction carryover. Taxpayers should consult with a tax professional to learn if this strategy makes sense based on their personal circumstances. IRS Publication 526, “Charitable Contributions,” includes detailed information on this topic.
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