2012 Loophole on Age 70 ½ IRA Charity Contributions

I had a call last week on what the rules are for the 70 ½ IRA owner making a direct distribution to a charity.

You may recall that – if you are a certain age – you can make distributions – up to a limit - from an IRA directly to a charity. The age is 70 ½ and the limit is $100,000. Why would you do this? There are several reasons:

(1) The first, of course, is that you are charitably inclined and have the means to do so.

(2) Second, the distribution counts toward your minimum required distribution (MRD). You have to pull the money out anyway.

(3) Third, you get to omit the distribution from income.

(a) This doesn't increase your adjusted gross income, which could have bad side effects (such as raising your Medicare premiums).

(4) Fourth, there is no charitable deduction.

(a) Which is OK, as you leave-off both the income and the deduction. In fact, you are ahead in a state that does not allow for itemized deductions.

What is the issue here? The issue is that the IRA/charity option was one of those tax law provisions extended with the most recent tax bill - the one signed in January 2013. People may have intended to make a direct distribution to charity but did not do so, waiting for clarification on 2012 tax law.

There is a surprise in the tax bill. You can still write a check by January 31, 2013 to a charity and have it count toward 2012. Let's say that you took out $26,000 from your IRA in December and made contributions of $10,000 before year-end. You can write checks for the balance ($16,000) and recast the entire $26,000 as a direct distribution in 2012.

2013 becomes 2012? I am thinking time travel, and that makes me think of....

What if you distributed in 2012? There are two possibilities:

(1)   You distributed directly to the charity

This is the best answer. You leave both the income and deduction off your return.

(2)   You distributed to yourself

            Oh oh. There are again two possibilities:

(1)   You distributed to yourself in December

                                   

As long as you write a check to charity by January 31, the IRS will consider this a direct distribution in 2012.

(2)   You distributed to yourself before December

There is nothing you can do. You will have income and a corresponding deduction. Hopefully there will be no harm, no foul. In Ohio, however, there is harm, as Ohio does not allow for itemized deductions.

There will be yet another consideration in 2013. Remember the new ObamaCare taxes (the 0.9% Medicare and the 3.8% investment income)? Those kick-in at $200,000 or $250,000 of income, depending on whether one is single or married. Now you have a very real reason to leave that IRA distribution off your income for 2013. You DO NOT WANT your adjusted gross income to hit that $200,000 or $250,000 stripe.

Portney’s Complaint or I’m Late, I’m Late For A Very Important Date

Do you extend your individual income tax return? More specifically, do you rely upon your tax advisor to extend the return for you?

There was a warning shot concerning extensions last year in Tesoriero v Commissioner. As a practicing tax CPA, it gave me pause.

Anthony and Eleanor Tesoriero had used the same CPA form (Portney & Company) for over a quarter of a century. The firm prepared approximately 1,000 individual tax returns annually (that is a lot). Of those, approximately 400 to 450 went on extension.

The firm had procedures. They would prepare the extensions and give them to the secretary, who would address and seal the envelope, take it downstairs and drop it in the mailbox. The firm did not use registered or certified mail. They did use a postage meter but did not keep a record or mail log.

Jack Portney extended the Tesoriero return in April 2005. He did not spend a whole lot of time estimating the numbers. Rather he took the estimated tax payments and showed that amount as both tax due and tax paid-in. He did not even include the withholding taxes from Mr. or Mrs. Tesoriero’s W-2s.

On August 15 the Tesoriero's filed their individual income tax return.

The must have had a good year, as their liability was around $280,000. Jack had extended the tax return showing a liability and tax paid-in of around $69,000.

The IRS sent a penalty notice that the return had not been extended. This made the return late-filed, and the late-file penalty is 5% per month.

            OBSERVATION: 5% of a big number is likely to be a big number.

The Tesoriero’s were not amused. They contested the penalty, explaining that the CPA had extended the return and therefore it was not late-filed. With that explanation, would the IRS be kind enough to abate the penalty?

The IRS did not and the matter went to the Tax Court.

In comes Jack Portney to explain his tax extension procedures. He was certain that the extension was mailed. It may not have been received, but it was mailed.

There is a presumption in the tax Code that a timely mailed return is timely received by the IRS. The issue with that presumption is when the return gets lost. One then needs a fallback position, and that fallback is to use certified or registered mail or an authorized delivery service. There have been court decisions that allow for other extrinsic evidence, such as an accountant’s mail log. Not all courts agree on the use of extrinsic evidence, however.

The Tesoriero’s were unfortunately in the Second Circuit, and the Second Circuit had previously decided that it would not accept extrinsic evidence to prove timely mailing. The Second Circuit includes New York, and there you simply have to use certified or registered mail or an authorized delivery company.

Here is the Court:

... such testimony is irrelevant in a case appealable in the Second Circuit. Mr. Portney did not mail the Form 4868 via certified or registered mail, nor did he use presumption of delivery. Because we cannot establish that respondent ever received the Form 4868, we cannot find that petitioner timely filed a valid extension request. Because the purported Form 4868 was not valid, petitioner did not timely file his 2004 tax return."

The Tesoriero’s came back and argued that they had relied upon a professional, and that surely this oversight could not be their fault. After all, how could they know the mail procedures that their CPA was using?

Here is the Court again:

Thus, petitioner can no more rely on Mr. Portney to file the extension than to file the return. Furthermore, the Court of Appeals for the Second Circuit has held that reliance upon an adviser to file an extension request does not constitute reasonable cause. Thus, petitioner's reliance upon Mr. Portney does not constitute reasonable cause."

The Court decided that the Tesoriero’s were subject to the late filing penalty.

My Take: Good grief! I practice in the Sixth Circuit, not the Second, but that does not mean that we do not have clients around the country – or the world - for that matter. Is a tax advisor to review every client for their specific Circuit and adjust his/her extension procedures accordingly?

Some things that Jack Portney did are standard: the postage meter, the secretary, the extensions in the mailbox. Others not so much: not keeping a mail log, for example. But a mail log would not have saved Tesoriero, as that would be considered extrinsic evidence.

Electronic filing may soon take this issue off the table. E-filing gives practitioners feedback on IRS acceptance, so any non-acceptance would be immediately flagged and corrected. This case gives an advisor (like me) impetus to insist upon e-filing all extensions.

I do feel bad for the Tesoriero's. I presume they claimed against their accountant’s malpractice or E&O insurance. Still, how can they be held responsible for tax arcana like this?