The Tax Cut and Jobs Act of 2017 fundamentally changed the landscape of tax efficient charitable giving for investors and retirees. With the elimination of many miscellaneous itemized deductions, the implementation of a cap on state and local tax deductions at $10,000 (previously uncapped), and the increase of the standard deduction to $24,400 (2019), a larger percentage of taxpayers are claiming the standard deduction than ever before. As a result, the tax benefit of traditional charitable gifting has been greatly reduced, or in some cases, eliminated entirely.
While some of the tax benefits for charitable gifting have been eliminated, for taxpayers who are age 70 ½ or older and have an Individual Retirement Account (IRA), there is an often-overlooked solution to maximize your charitable tax benefit: the Qualified Charitable Distribution.
What is a Qualified Charitable Distribution?
Qualified Charitable Distributions (QCD’s) were originally enacted in the Pension Protection Act of 2006 and were scheduled to “sunset” at the end of 2007. Between 2007 and 2015, Qualified Charitable Distributions were annually voted on and renewed by Congress, finally being immortalized in the Internal Revenue Code in Section 408(d)(8).
A QCD is a charitable tax-planning strategy that allows a qualifying individual to make a distribution directly to a qualified 501(c)(3) charity from his or her IRA without having to include the distribution in his or her income. Many charities are qualified under 501(c)(3), however, a notable exception is that a Qualified Charitable Distribution cannot be made to a private foundation or a Donor Advised Fund.
Distributions can be made from a Traditional or Rollover IRA in addition to an employer-associated IRA, such as a SEP or a SIMPLE IRA, as long as the owner (or the employer) did not contribute to the IRA within the same calendar year.
A QCD cannot, however, be made from a 401(k) or 403(b) account without first rolling the account into an IRA.
Rules for a Qualified Charitable Distribution
In order to qualify as a QCD, there are a few requirements that must be met.
The IRA owner must be at least 70 ½ years old to realize the benefit of the strategy. If the account owner is not at least 70 ½, the IRA distribution will be includable in income, negating the income tax benefit.
The QCD is limited to $100,000 per individual, per calendar year. Charitable distributions made from an IRA in excess of the $100,000 would be included in income, negating the income tax benefit on the excess amount.
Because QCD’s are excluded from income, you cannot “double dip” and claim a charitable deduction on your income tax return. You can, however, continue to claim deductions for other charitable gifts made from taxable accounts. Choosing to make Qualified Charitable Distributions does not affect your ability to deduct your non-IRA charitable donations.
Why Should I Make a Qualified Charitable Distribution?
QCD’s can satisfy Required Minimum Distribution (“RMD”) requirements from your tax-deferred accounts. For many, these distributions help supplement social security to fund lifestyle expenses. However, for others, taking unneeded but necessary distributions from an IRA and recognizing income on those distributions can be burdensome. Because a Qualified Charitable Distribution satisfies RMD requirements, it can be a better solution for these taxpayers. Note that RMD’s have been suspended for the tax year ending December 31, 2020 under the CARES Act.
QCD’s are an effective tax planning tool because the distribution from an IRA to the charity is not included in a taxpayer’s adjusted gross income. As such, a taxpayer may avoid moving into a higher income tax bracket and in addition may be able to qualify for other miscellaneous itemized deductions that are subject to income phaseouts like medical expenses (in excess of 10% of AGI).
While not phased out at higher income levels, monthly Medicare premiums also can increase if the beneficiary earns in excess of $85,000 (single) or $170,000 (married). By not including the distribution into income, you can avoid being subject to these higher premiums.
Additionally, with the increase of the standard deduction to $12,200 for individuals and $24,400 for married couples, many households receive little to no benefit from traditional charitable gifting if all other deductions are less than the standard deduction. For many married couples, the cap on deductibility of State & Local Taxes at $10,000 annually and the disallowance of most itemized deductions has reduced the tax benefit of traditional charitable gifting. Take the example below:
Example: A couple has required IRA distributions of $50,000 annually, state income and property taxes of $10,000, medical expenses of $11,000, and would like to make $10,000 in charitable gifts.
By making a Qualified Charitable Distribution instead of gifting through traditional methods (i.e. from non-IRA accounts or from IRAs and recognizing taxable income), the couple could reduce their Adjusted Gross Income to $90,000 and claim the standard deduction of $24,400, reducing taxable income (what your federal tax calculation is based on) to $65,600. Through traditional charitable gifting, the couple benefits only slightly from their $10,000 charitable gift from a tax standpoint, because their itemized deductions only exceed the standard deduction by $1,600. By making a Qualified Charitable Distribution from the IRA, the couple in this example could save 12% in federal taxes or approximately $1,000. By making charitable gifts the traditional way, the couple may also be subject to higher Medicare premiums, further increasing the benefit of making a Qualified Charitable Distribution.
As a result of the Tax Cuts & Jobs Act of 2017, Qualified Charitable Distributions have become a more effective tax planning tool for charitably inclined individuals. Because all tax situations are unique, please reach out to a Round Table Wealth Advisor to discuss Qualified Charitable Distributions along with your other philanthropic objectives.