Tax Consequences of Donating Inherited IRAs

Donating your inherited IRA to charity can reduce your tax burden.
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When you inherit an IRA, you must take minimum distributions from the account each year or empty the account within five years. To limit the tax impact, you may want to give the money to charity. However, you don't always break even when you make the donation. Therefore, if you want to avoid increasing your tax liability, you might need to hold back some of your distribution to cover taxes.

Taxability of Distributions

When you take a distribution from an inherited IRA, the distribution is taxable in the same way it would have been if the decedent had taken the distribution, according to IRS Publication 590. For example, if you took money from a traditional IRA, the distribution counts as taxable income. A distribution from an inherited Roth IRA incurs no taxes if the decedent opened the account at least five years before his death.

Tax Deduction for Donation

According to IRS Publication 526, the recipient of your donation must be a qualified charity in order for you to rake a deduction. Individuals don't qualify, so no matter how deserving your kid brother is of money for college, you can't claim a deduction for the proceeds from the inherited IRA by giving the proceeds to him. To claim the tax break, you must itemize your deductions.

Limits on Deduction

Just because your donation is deductible doesn't mean you can deduct the entire amount in the year of your deduction. According to IRS Publication 526, your deduction each year is limited to a percentage of your adjusted gross income, depending on the type of charity to which you make the donation and the type of the property you contribute. If your donation exceeds the limits, you can carry over the excess up to five years in the future.

You total deductions for contributions to all charities may not exceed 50 percent of your adjusted gross income for the year. For contributions to some organizations, the limit is 30 percent, and for others it is 20 percent.

Tax Consequences

Giving all of the inherited IRA to charity doesn't mean your taxes will balance out. To claim the deduction, you must itemize, which means giving up the standard deduction, and your donation might exceed the annual limits based on your AGI. If you already itemize, you'll break even because the amount of the distribution is offset by the tax deduction. However, if you wouldn't otherwise itemize, you'll likely come out slightly behind. For example, assume that your itemized deductions not including your donation total $3,900 and your standard deduction is $5,900. If you take a taxable $10,000 distribution from the inherited IRA, your taxable income goes up by $10,000. When you itemize, assuming you can deduct the entire $10,000, you replace your $5,900 standard deduction with a $13,900 itemized deduction, an increase of only $8,000. Therefore, you'll have an extra $2,000 of taxable income.

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