Posted by Michael H. Abernathy Jr, CPA
Although Congress incentivizes individuals to save for retirement by allowing various tax-free savings vehicles, they do eventually require taxpayers to dig into their nest eggs. When taxpayers reach age 70 ½ they must withdraw at least a specified minimum amount of funds from their retirement accounts each year. These required minimum distributions (RMDs) are generally taxable income to the taxpayer; a situation which often causes taxpayers both unnecessary income withdrawals and unwanted taxes. However, for taxpayers over age 70 ½, there is a useful tool available which allows those who are charitably inclined to make efficient use of these distributions while at the same time providing substantial tax benefits: the qualified charitable distribution (QCD).
QCDs are distributions made directly from an IRA to a charitable organization. These distributions satisfy any existing RMD requirements. QCDs are not deductions for the taxpayer, but they do allow for the exclusion of retirement income on their tax return, which means taxpayers avoid federal income tax on their RMD (and possibly avoid state income taxes as well). This income exclusion reduces a taxpayer’s adjusted gross income (AGI) for the year, which brings with it a host of additional benefits beyond simply avoiding income tax on the distribution. Reduced AGI for a taxpayer also means the minimum threshold for deductible medical expenses is lowered, the amount of allowable passive losses is possibly increased, the taxable portion of their Social Security benefit is potentially reduced, and perhaps even that their part B and D Medicare premiums will be lowered for the following year. These additional benefits are enticing for many taxpayers who have reached retirement age.
Moreover, since QCDs are not deductions, they can be utilized even if a taxpayer does not itemize, which, with the advent of the Tax Cuts and Jobs Act of 2017 (TCJA), is a benefit now more significant than ever. The TCJA ushered in a substantially increased standard deduction such that many taxpayers who itemized in the past now no longer do so. This means deductible contributions no longer provide the tax benefit they once did to many taxpayers. Making donations in the form of a QCD allows these taxpayers to benefit from the TCJA’s increased standard deduction while still reaping a tax benefit from their donations.
The bottom line is that QCDs make sense for a great many taxpayers. Yet, a few nuances to QCDs do exist which taxpayers should be aware of. A few of these key areas are listed below:
- Must be 70 ½ years of age – Taxpayers must reach age 70 ½ to be eligible to make a QCD (which is the age RMD requirements are triggered). Taxpayers should remember that current tax law states they must be age 70 ½ at the date of the gift, not just that they reach age 70 ½ by the end of the tax year.
- Annual $100,000 limit per person – The total amount of QCDs that may be distributed per year is $100,000 per person. For married taxpayers, this means each spouse individually gets their own $100,000 limit which cannot be shared with or allocated to their spouse. Taxpayers may make individual QCDs of any amount to any number of qualified charities so long as the total of all such donations falls within the annual limit.
- QCDs may only be made to 501(c)(3) organizations – Generous taxpayers may have donor-advised funds or private foundations. Though such vehicles may be utilized for itemized tax-deductible donations, QCDs may not be made to these types of funds; only 501(c)(3) organizations are eligible to receive QCDs.
- QCD’ may only be cash – Taxpayers may not contribute marketable securities or real property through QCDs; only cash donations are permitted. Taxpayers should note that some IRA custodians provide checkbooks to account holders so they can personally write donation checks from their IRA at their convenience. Any such checks must be cashed by the recipient before December 31st to count for the tax year; therefore, taxpayers should not wait until the last minute to make their donations.
- 401(k) and 403(b) plans – Although 401(k) and 403(b) plans do have RMD requirements, the IRS does not currently allow QCDs to be made from these types of accounts. However, there is a simple work-around: upon retirement, taxpayers can transfer some of their 401(k) or 403(b) account balance to a personal IRA account. Taxpayers may want to consider this type of rollover if they are charitably inclined, but they should discuss the prospect of rolling over any funds with a tax or financial advisor to understand all the implications of such a rollover before doing so.
- Continuing SEP and SIMPLE IRAs – Certain small business plans (such as SEP and SIMPLE IRAs) that receive contributions in a tax year are not eligible to make QCDs in that year, even though they may have an RMD requirement. To get around this, taxpayers can aggregate these accounts with any other IRAs they might have to arrive at one RMD requirement for all their accounts. The taxpayer can then take their aggregated RMD from an IRA that is eligible to make a QCD (such as a traditional IRA).
- Roth IRAs – Although QCDs are permitted to be made from Roth IRAs, Roth accounts neither have RMD requirements nor are the distributions taxable; therefore, there is likely no tax benefit for a taxpayer to make a QCD from a Roth account.
Taxpayers who are charitably inclined should strive to make their donations in the most tax-efficient manner. The QCD is a seldom-used tax planning tool available to taxpayers over age 70 ½ that many are not aware of. If you think a QCD may make sense for you, be sure to consult your tax advisor for guidance.