Enhance charitable contribution tax savings using a Qualified Charitable Distribution (QCD)
If you are age 70 ½, have an IRA, and want to make charitable contributions tax efficiently, you should consider a qualified charitable distribution (QCD). A QCD is a distribution from an IRA that is transferred directly from the IRA custodian to the charity. When the taxpayer files their tax return, they can then exclude the amount of the QCD from their taxable income. Please note, there is no charitable deduction on Schedule A associated with the QCD as the amount was excluded from income initially. View this in contrast with the taxpayer who does not choose to make a QCD, but rather takes his regular IRA distribution normally and then decides to donate to these after-tax dollars to charity. This taxpayer would report the full IRA distribution as taxable income and then deduct the donation to charity as an itemized deduction on Schedule A. As we will discuss, this second option is often not the most tax efficient means of making a charity donation.
Before discussing the benefits, let’s briefly discuss who can make a QCD and how it is accomplished.
Who can make a QCD
- You must be at least 70 ½ years of age to make a QCD.
- The maximum amount that you can direct to charity from your IRA in any one calendar year is $100,000. If married filing jointly, taxpayer and spouse can each direct up to $100,000 in any calendar year, as long as the distributions come from his/her respective IRA.
- QCDs can be made from traditional IRAs, rollover IRAs or inherited IRAs.
- QCDs can come from a SEP IRA or and SIMPLE IRA if the plan is not active. The IRS considers the plan to be inactive if no employer contributions are made to the SEP/SIMPLE IRA in the same year in which the QCD is made.
- QCDs can be made from ROTH IRAs, but there is no tax advantage in doing so as distributions from ROTH IRAs are already tax-free.
Who can accept a QCD
- The recipient of the QCD must be a public charity approved by the IRS.
- The recipient of the QCD cannot be a donor-advised fund, supporting organization, private foundation, or split-interest charitable trusts.
How to make a QCD
- The distribution to the charity must be transferred directly from the IRA custodian to the charity. The funds cannot come to the owner first and then go to charity.
- No benefits can be received from the charity in return for making the QCD (i.e. athletic tickets, meal/tickets to fundraising events)
Now for the good part…how does making a QCD save you taxes?
Benefits of making a QCD
- Many types of taxes and phase-outs of deductions or credits are based on your adjusted gross income (AGI). Since the QCD is not included in income, it keeps your AGI lower, so that you can potentially stay below certain thresholds.
Consider the two following examples:
Bill’s 2019 income is expected to be about $325,000 which includes an RMD from his IRA of $100,000. Bill donates $80,000 to his favorite charity but he does not make a QCD. Rather he takes his full $100,000 RMD and then writes a check to the charity for $80,000.
Bob is expecting the same income as Bill; however, Bob’s accountant sent him an article about the benefits of making a QCD so he directs $80,000 from his IRA to his favorite charity rather than writing a check from his after-tax distribution.
In this scenario, Bill’s investment income would be subject to the net investment income tax (additional surtax of 3.8%) because his AGI is over the $250,000 applicable threshold. However, Bob’s AGI after making the QCD is only $245,000, so his investment income will not be subject to the net investment income tax.
- With the recent enactment (2018) of the increased standard deduction ($24,400 for 2019 joint filers), elimination of 2% itemized deductions (i.e. investment management fees, out of pocket employee expenses, tax prep fees) and the $10,000 maximum allowance for state tax deductions, more and more taxpayers will claim the standard deduction rather than itemize. Thus, if you claim the standard deduction, you will lose the tax benefit of making charitable contributions. Since QCDs directly reduce your taxable income and essentially “bypass” itemized deductions, you can still get a benefit from making a charitable donation and take the standard deduction.
- QCDs can satisfy the owner’s required minimum distribution (RMD). This allows you to meet the RMD rules and meet your charitable giving goals without recognizing the RMD income.
- If you have basis in a nondeductible traditional IRA, QCDs are considered to be made from the taxable funds first. Normally when a distribution is taken from an IRA with basis, the tax-free and taxable portion are pro-rata.
Summary of savings
If you are 70 ½, have an IRA and have charitable giving goals, you should consider using the QCD to enhance the tax benefit. You can potentially save tax and qualify for tax credits due to a lower AGI. You can also recognize the benefit of charitable giving while claiming the higher standard deduction. You do need to be cautious to be sure you are making the QCD to a qualified charity and not receiving any benefits in return.
We would be pleased to discuss with you in more detail how this charitable giving technique might work for your specific financial situation. Contact our Family, Executive & Entrepreneur Advisory Services team | Email | 804.747.0000
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The information contained within this article is provided for informational purposes only and is current as of the date published. Online readers are advised not to act upon this information without seeking the service of a professional accountant, as this article is not a substitute for obtaining accounting, tax, or financial advice from a professional accountant.