Take-Away:  Roth IRA conversions options exist under the 2020 charitable giving option created under the CARES Act. While not for everyone, for those charitably inclined donors with large IRAs, this may be a good year in which  to consider a Roth IRA conversion.

Background: The Cares Act, which passed on March 23, 2020, contains a provision that is intended to encourage charitable giving. Specifically, the provision lifts, but only for 2020, the adjusted gross income (AGI) limitation on the cash amount that an individual can gift to charity. Prior to the CARES Act, that charitable deduction limitation was ‘capped’ at 60% of the donor’s AGI in a single tax year. Any excess given to charity, above that 60% limitation had to be ‘carried over’ and used in the next 5 years. For 2020, an individual can now gift cash up to 100% of their AGI to charity and deduct the entire gift all this year if they itemize their income taxes for 2020.

Not COVID-19 Limited: This expansion of the limitation to 100% of a donor’s AGI is not limited to those charities that are related to the COVID-19 crisis. Almost all charities will qualify.

Election: The CARES Act permits a taxpayer to elect whether to apply the 100% of AGI limit to each qualifying cash contribution. The failure to make this election will otherwise convert such charitable contribution to a 60% of AGI limitation contribution; any excess above the 60% limitation would then be carried forward for five years rather than be fully utilized in 2020.

Charities Limited: Much like the limitations placed on qualifed charitable distributions (QCD) from IRAs, which are not available for direct IRA distribution gifts to private foundations, ‘supporting organizations’ or donor advised funds (DAF) [IRCC 408(d)(8)] none of these types of charities can qualify for the immediate charitable deduction of up to 100% of the donor’s AGI for the year. Apparently Congress is concerned that charitable gifts to private foundations, ‘supporting organizations’ or DAFs do not have to be immediately used to carry out charitable purposes that the charitable deduction is designed to encourage, which is why QCD’s, and this 100% of AGI opportunity to gift care, are denied to this narrow class of charities.

QCD/DAF Limitation: There is some ambiguity, however, under the CARES Act with regard to cash gifts to a DAF. The CARES Act disallows the 100% of AGI limitation for contributions that are “for the establishment of a new or the maintenance of an existing donor advised fund.” [CARES Act Section 2205(a)(3)(B)(ii.)] No one is quite sure what this language means, as it is different than the flat prohibition of QCD’s to DAFs under IRC 408(d)(8). Possibly a cash gift to a DAF could be made, up to 100% of the donor’s AGI for 2020, but only if that cash gift was promptly distributed by the DAF and not held back for distributions in later years. To be safe, probably cash gifts to DAFs in 2020 should be limited to 60% of the donor’s AGI for the year, unless the IRS provides some better clarification on the ambiguous language that is used in the statute.

Examples: 

#1: Todd contributes 35% of his 2020 AGI in cash to his donor advised fund established at the local community foundation. Todd also contributes 65% of his 2020 AGI in cash to his church. Todd can deduct 65% of his AGI contribution to his church. However, none of Todd’s contribution to his donor advised fund will count towards the 100% AGI limitation.

#2: Brad contributes 25% of his 2020 AGI in property to his church. Brad makes a cash gift to his church equal to 75% of Brad’s 2020 AGI. Brad can deduct both gifts up to 100% of Brad’s AGI for 2020.

#3: Teresa contributes 25% of her 2020 AGI in appreciated stock to her donor advised fund established at the local community foundation. Teresa also gifts cash equal to 35% to her donor advised fund. Teresa also gifts 40% of her 2020 AGI using nonappreciated property to her church.  Teresa can deduct 50% of her AGI for 2020. Reasons: (i) the 60% of AGI given by Teresa’s to her donor advised fund does not qualify for the 100% AGI limitation; and (ii) the 65% of Teresa’s AGI given in property by her does not qualify for the 60% of AGI limitation (its not cash). Accordingly, 50% of Teresa’s AGI limitation applies to the gifts of cash and the nonappreciated property by her (with 25% of Teresa’s AGI carriedforward along with the entire 25% gift of appreciated stock, to future tax years.)

Planning Opportunities:

Maximize Benefit of the 100% AGI Cash Gift: If a donor intends to maximize the benefit of his/her charitable contributions of cash in 2020, he/she should limit the qualifying charitable cash contributions to their taxable income  which is determined only after all other itemized tax deductions are used (other than the charitable contribution deduction.) Otherwise, the excess deductible cash gifts will be subject to the carry-forward rules to be used is future tax years.

IRA Roth Conversion: A donor can increase his/her AGI by converting an IRA (or other qualified retirement account) to a Roth IRA. The conversion will expand the reported taxable income that is available for the 100% of AGI limitation. This conversion offers the opportunity for highly charitably inclined donors who have an IRA to accomplish two goals at once: (i) obtain a larger charitable income tax deduction in 2020; and (ii) pay no federal income tax on the Roth IRA conversion, which income tax is offset by the large 100% charitable deduction.

Example: Andrew will report $1.0 million of AGI for 2020. Andrew wants to make a $3.0 million cash gift to the local university’s capital campaign in 2020. Last year, Andrew’s income tax charitable deduction would have been limited to $600,000. In 2020, the CARES Act will allow Andrew to claim a charitable contribution of $1.0 million. However, that still leaves Andrew with a $2.0 million charitable gift to the university that will be the subject of a deduction carry-forward, then subject to the 60% of AGI limitation in 2021 and future tax years.)

Suppose that Andrew has a large traditional IRA with more than $2.0 million. Andrew can convert that $2.0 in his traditional IRA to a Roth IRA in 2020. This enables Andrew to claim a full charitable income tax deduction for his $3.0 million gift to the university. In addition, with the conversion of Andrew’s traditional IRA to a Roth IRA, he will enjoy tax-free earnings on his Roth IRA in future years, and he will avoid having to take any required minimum distributions from that Roth IRA.

Conclusion: There is a lot yet to be understood with regard to the CARES Act and its numerous provisions. Hopefully the IRS will provide some answers to its ambiguous provisions. One planning opportunity to consider, however, is the potential for a Roth IRA conversion in 2020.