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Charitable giving may already be a part of your annual tax and estate planning. But if you are over age 70 ½ and have an IRA, you can donate directly from the IRA, satisfy your Required Minimum Distribution, and reduce your taxable income. It’s called a Qualified Charitable Distribution (QCD), and it doesn’t require you to itemize your taxes to receive a charitable tax benefit. In Part III of a 7-part series, “Tax Saving Strategies for High Earners,” we uncover how a QCD works and reveal its often-overlooked tax-benefits.
What is a Qualified Charitable Distribution (QCD)?
A QCD is a non-taxable charitable distribution that can be made from eligible IRAs. These include Traditional, Rollover, Inherited, SEP or SIMPLE IRAs. When making a QCD, assets in your IRA are sent directly to a charity and the tax-free withdrawal is an exception to what would normally be considered ordinary taxable income.
In general, funds in an IRA receive tax-deferred growth. You get a tax-deduction in the year you contribute to your IRA, but typically pay ordinary income taxes when you pull money out in retirement. By gifting IRA assets straight to a charity, you are moving funds out of your IRA without paying taxes on them, as opposed to a normal withdrawal in which you would offset the taxes with the charitable contribution.
Do QCDs count towards RMD? Tax Benefits – and More
Once you reach age 72, you’ll need to begin taking Required Minimum Distributions from your IRA. These are taxed as ordinary income. The QCD can count towards your RMD, which satisfies the requirement to remove money from the IRA, but shelters it from taxes. And because it lowers your income – you may save taxes on your social security benefit, up to 85% of which is taxable. In addition, there are means limits on Medicare that require a surtax on Medicare Part B premiums over a certain level of income. A careful strategy to keep income low can reduce or eliminate the surtax.
If you don’t need income from your IRA to cover your expenses in retirement, a QCD is an effective way to help rid yourself of unwanted RMDs and pay less in taxes. For a QCD to count towards your RMD, money must be pulled from your IRA before the RMD deadline, which is generally the last day of the year.
If your QCD is larger than your current year’s RMD, the excess QCD cannot be applied towards satisfying your future year’s RMD. For example, if you made a $90,000 QCD and your current year’s RMD is only $70,000, you cannot apply the $20,000 difference towards satisfying next year’s RMD.
What is the maximum QCD I can make per year?
As a single taxpayer, the sum of your QCDs to various charities may not exceed $100,000 per year. If you’re married and file a joint tax return, your spouse may also make QCDs up to $100,000 if the charitable distributions come directly from his or her IRA.
You may only make a QCD with IRA funds that would have otherwise been taxed if distributed to your bank account. This means you cannot make a QCD with IRA contributions in which you did not receive tax deductions in the years you contributed. If your income was over the IRA Tax Deduction Limit in the years you contributed, the IRS may not have given you tax deductions. This income limit may vary based on your participation in your employer sponsored retirement plan. Before making a QCD, make sure to consult with your CPA to confirm it makes sense and is done properly.
How is a QCD reported on my tax return?
A QCD is tax-free and won’t be reported as income on your tax return. You will receive a 1099-R in January showing your IRA distributions from the prior year.
While this form should be given to your CPA, it doesn’t indicate the amount of your IRA distributions that were considered tax-free QCDs. To avoid overpaying taxes, make sure to let your CPA know how much of your distribution was considered a tax-free charitable gift.
If your QCD was $250 or more, the receiving charitable organization will also send you a confirmation letter. It’s a good idea to keep this for your records and send a copy to your CPA. To make sure you’ve collected all the right tax documents, refer to our Tax Filing Checklist.
Is a QCD more valuable than an itemized tax deduction for charitable giving?
It depends. BWM will work with your CPA to evaluate the several factors that may play a role in determining your most tax-efficient charitable giving strategy. One of those factors is your decision to itemize your taxes or take the standard deduction. . The IRS lets you to choose one of these two options as a way to reduce your taxable income each year, and we’ll help you weigh the pros and cons of each.
If you elect to itemize deductions, your taxable income is reduced by the sum of certain individual deductions allowed by the IRS. When you donate cash or appreciated assets from your non-IRA accounts, you may receive an itemized deduction for your charitable gift.
If you don’t itemize your taxes, your taxable income is reduced by the standard deduction. If the sum of your itemized deductions does not exceed the standard deduction, a QCD may be more valuable than donating your non-IRA assets to charity.
A QCD provides a tax benefit that feels like a deduction without needing to itemize your taxes. It’s a way to move otherwise taxable money out of your IRA, and the distribution does not count as income on your tax return.
What charities can receive a QCD?
You may make QCDs to various public qualified charities determined by current tax law. In general, these exclude private foundations and Donor Advised Funds. Before making a charitable gift from your IRA, BWM suggests contacting your CPA and the charitable organization in-mind to verify it can accept QCDs.
Who should consider making a QCD?
A QCD may provide the greatest tax benefits for a family with the following profile:
- Has a member 70.5 years or older with a large Traditional, Rollover, Inherited, SEP or Simple IRA
- Is charitable but typically takes the standard deduction.
- Would like to reduce taxable income in retirement.
- Does not need IRA income to cover living expenses.
- Would like to eliminate unnecessary RMDs.
How can BWM Financial help?
As part of our service to clients, BWM Financial will review your prior years’ tax returns and evaluate the tax-efficiency of your current charitable giving strategy. While we are not tax advisors, we can work directly with your CPA to evaluate the tradeoffs between gifting IRA funds directly to charity or stacking appreciated assets from your non-retirement accounts into a Donor Advised Fund. We’ll review your full financial picture to help you determine in what years to give, how much to give, and the most tax-efficient vehicles for gifting assets now or later in life.
If you need help with tax-efficient planning, please contact BWM. We will provide high-level advice that can be evaluated with your CPA and then implemented into your financial plan.