Charitable Planning Through IRA Accounts: The Right and Wrong Way to Do It

An IRA account may be subject to two different kinds of tax when its owner dies:  Estate tax and income tax.

First, the fair market value of the IRA account may be subject to Federal estate tax when the owner of the IRA dies.  In some states, like Maryland, the IRA account may also be subject to Maryland estate taxes or Maryland inheritance taxes (taxed along with other assets in the decedent’s Estate).  Furthermore, IRA distributions received by the owner’s Estate, or by other beneficiaries after the owner’s death, will be subject to income tax.  Charitable planning with IRA accounts may make it possible to avoid excessive estate, inheritance or income taxation, but the plan must be carefully drawn in order to make use of the charitable deduction.

The Wrong Way

The wrong way to craft the plan is to make a Trust the beneficiary of an IRA account and to then name, in addition to non-charitable Trust beneficiaries, a charity or charities to receive pecuniary distributions from the Trust.  This plan is problematic because if the Trust donates to a charitable beneficiary any of its interest in the IRA account in order to satisfy its pecuniary obligation, the distribution will not be eligible for the charitable deduction.  Instead, the donation will be considered a “transfer” under the Internal Revenue Code, thus subjecting the Trust to income tax on, at least, the fair market value of the IRA interest.  (Note:  the result here might be different if the Trust’s terms direct that payment to the charitable beneficiaries be made from the Trust’s gross income; nevertheless, there are much better ways to use IRA accounts for charitable gifting.)

The Right Way

Two right ways for the Estate to avoid income tax on IRA distributions to charities are as follows:

Option One: 

One option is to name a Trust as beneficiary of the IRA account and, in turn, to name a charity, or charities, as beneficiaries of the Trust who are specifically entitled to an interest in the IRA account.  In contrast to a pecuniary legacy, when a Trust distributes its interest in an IRA account to a beneficiary pursuant to the terms of the Trust, the distribution is not considered a “transfer.”  Thus, the distribution does not itself subject the Trust to income tax.  (Note:  With this strategy, the Trust’s beneficiaries may only include charitable entities.)

Option Two:

The second option is to simply name the charity (or charities) as the account’s beneficiary.  This strategy will not only avoid subjecting the Estate to income tax liability; it will also provide the Estate with a charitable deduction on its Estate tax return.

As you can see, subtle details in an estate plan can make big differences in preserving your legacy, especially when it comes to IRA and charitable giving.  Call us at (301) 468-3220 or email us at for more information.

-  Gary Altman, Esq. and Coryn Rosenstock

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