When you look at my first photo, do you immediately think, Tax Shelter?
In 1953 I lived next door to Mr. Sandy Sandstrom, LPA. LPA or Licensed Public Accountant was a professional designation which was ultimately replaced by our modern day CPA or Certified Public Accountant designation. Eventually LPAs became extinct.
When I was 10 years old, Mr. Sandstrom was one of my first mentors. I loved to go next door and hang out with Mr. Sandstrom in his in-home accounting office.
One day Mr. Sandstrom held up a yellow No. 2 lead pencil and said, “Joe, do you realize you can earn a fine living with just a No. 2 pencil if you are an accountant? You can make money counting other people’s money.”
Nine years later I found myself studying accounting at the University of Puget Sound with lofty plans of becoming a CPA. The two most memorable things I learned during my accounting studies were as follows:
- While working on accounting practice sets inside a soundproof student study booth, I learned to cuss like a sailor who had been smashed in the head one more time with the boom of a mainsail.
- I learned that wearing a green eyeshade, a rubber finger protector, and manning a No. 2 pencil was not for me. Accounting was not going to give me enough interaction with people. Besides, I thought all my cussing when the books refused to balance was not becoming to my genteel persona. After completing 15 hours of accounting I changed my major.
From that day forward, Professor Roy J. Polley called me “the Benedict Arnold” of the UPS Accounting Department.
While I went on to do many things in life other than accounting, I never lost my respect for the profession of accounting, especially as related to intelligent tax planning.
Starting in 2014, as I approached the magic age of 70 1/2, which triggers the Required Minimum Distribution (RMD) for anyone possessing a Traditional IRA, I followed each year’s constantly changing Congressional actions related to charitable gifting tax planning devices.
Please don’t confuse Traditional IRA plans with Roth IRA plans, because the rules are different.
Smart money managers embraced Traditional IRA plans. Participants were able to make contributions with pre-tax dollars. Even if the investment earned zero, the savings impact of investing with pre-tax dollars was equivalent to a 15% — 25% return. Once the dollars were inside the plan, earnings and gains were allowed to grow income tax-free.
Distributions, on the other hand, are normally taxable events. Our Federal Government gives us a tax break which provides us the opportunity to amass and grow a larger retirement fund for the day we are awarded our gold retirement watch.
The year in which we reach the age 70 1/2, our Federal Government says, “Enough is enough.” We must now begin taking distributions and paying income tax on those distributions, unless… Unless is the key word in this paragraph. We must pay income tax on our distributions unless instead of taking the money for our own personal use, we transfer the money or stock directly to a qualified charity.
Failure to meet the RMD requirement can mean severe penalties. One false step and IRS will make you feel like you have been smacked on your wallet pocket with a 2 X 4 with a rusty nail in it.
In the past, Congress waited until December of each year to decide on gift giving taxation rules. This year Congress decided to make the tax-free gift giving provision permanent. Permanency makes it much easier to manage charitable giving on a more powerful hard dollar basis.
Hard dollars = What you have when Uncle Sam doesn’t collect income tax from you. Earn a dollar, keep a dollar.
Soft dollars = What you have after Uncle Sam collects income tax from you. Earn a dollar and keep .75 cents.
Let’s look at 3 scenarios where the taxpayer wishes to donate $1,000 to his favorite charity. The scenarios should demonstrate how the hard dollar / soft dollar concept works.
SCENARIO 1: $1,000 of ordinary soft dollar income – $250 income tax = $750 available for charitable gifting.
SCENARIO 2: $1,333 of ordinary soft dollar income – $333 income tax = $1,000 available for charitable gifting.
If the taxpayer is both generous and clever, then Congress has handed him a powerful hard dollar financial gifting tax planning tool which is described in Scenario 3.
SCENARIO 3: $1,000 of hard dollar Traditional IRA funds – ZERO income tax = $1,000 of available for charitable gifting.
If the donation moves from the IRA directly to the designated charity without the taxpayer ever having receipt of the funds, the funds move income tax-free. That means $1,000 worth of hard dollars equals a $1,000 donation.
- No income tax due.
- The taxpayer complies with the Required Minimum Distribution IRS mandate and thus avoids tax and penalties up to a brutal 65%.
- Donations ranging in amounts from $1 to $100,000 can be made each year.
- If a taxpayer decides to make a $1,000 donation, the donation is made to the charity in hard dollars.
- The transfer does not increase the adjusted gross taxable income of the taxpayer.
- Keeping RMD dollars out of adjusted gross income can provide a positive impact on the issue of Medicare high-income surcharges.
- Keeping RMD dollars out of adjusted gross income can reduce the tax impact on the taxpayer’s Social Security benefit.
Taxpayers can practice philanthropy with part or all of their RMD. A taxpayer can make his tax-advantaged transfer to one qualified charitable entity or to several. Donations can be made in varying dollar amounts to various charities. A taxpayer can donate part and keep part of the RMD for his own use. Of course, income tax will be due on the portion of the RMD which is distributed to the taxpayer.
If you would like to learn more about RMD, click my link to a helpful Forbes article concerning 3 Common IRA Mistakes.
If you own a Traditional IRA and are already making charitable contributions with soft dollars, consider changing your charitable gifting to the hard dollar approach.
If you are not yet making charitable contributions, give serious consideration to doing something even if your personal economics dictate that you start out small. If you do something, you too, will be making the world a better place.
In closing, to prevent either of us from following Al Capone into prison for tax evasion, I encourage you to consult with your CPA for professional guidance. I am not a CPA.
If you do not have a relationship with a CPA, may I recommend mine? Not only is he highly skilled and knowledgeable, he exudes common sense and is easy to talk with.
Mr. Ron Bassage, CPA
7502 Lakewood Drive W, Suite B
Lakewood, WA 98499