QCDs – An Underutilized Philanthropic and Tax-Planning Tool
The Tax Cuts and Jobs Act (TCJA, 2017) significantly altered the tax landscape by lowering marginal rates, nearly doubling the standard deduction (and indexing it to inflation), and capping or eliminating several categories of itemized deductions. For most taxpayers, the net impact of these changes was positive (i.e., modestly lower tax liability). Even so, the percentage of Americans who found it worthwhile to itemize deductions was roughly cut in half, from 20-25% before the TCJA to less than 10% afterward.
One strategy that evolved in response to the TCJA was to “bunch” charitable donations in alternating tax years. For example, an investor might combine several years’ worth of planned gifts into a single lump-sum donation during a year they planned to itemize, then revert to taking the standard deduction in subsequent years. Many of our clients utilize this strategy via gifts to Donor-Advised Funds (DAF), which allows them to front-load the tax benefits of gifting in a single year but continue dispersing funds to their favored organizations over time.
Yet another charitable giving strategy—available since 2006 but not widely utilized—is the Qualified Charitable Distribution (QCD). This option allows IRA owners aged 70.5 and above to directly distribute to qualified charities from their IRA account (up to $105K per individual in 2024 and a bit higher next year because of inflation indexing).
The main benefit is that the amount of the distribution counts toward the required minimum distribution (RMD) but is excluded from the adjusted gross income of the account holder. Since these are direct gifts made from pre-tax assets, there is an immediate embedded tax benefit (equal to the IRA owner’s marginal tax rate multiplied by the dollar value of the gift). IRA owners realize this tax benefit on top of the standard deduction if they cannot itemize.
Who is a Good Candidate for a QCD?
A QCD is ideally suited for someone aged 70.5 or older with an IRA account who makes regular but modestly sized charitable gifts. It is especially useful for IRA owners who have a large balance or have reached the age where they are obligated to take annual Required Minimum Distributions (RMDs).
In some situations, a QCD may also help taxpayers keep their adjusted gross income below a threshold that preserves eligibility for other deductions or minimizes additional taxes such as the tax on social security benefits, the Net Investment Income Tax (NIIT), or Medicare’s Income-Related Premium Adjustments.
A Few Important Guidelines to Be Aware Of
We recommend making donations from your IRA earlier rather than later in the year because of the “first dollars out” rule. This rule stipulates that the initial withdrawals from an IRA are automatically applied to satisfy your RMD obligations. This could prevent you from benefiting from a donation once the annual RMD amount has been met.
Payments must be made directly to an eligible operating charity from the IRA account, not to you. Donations cannot be made to private foundations, split-interest charitable trusts, or Donor-Advised funds.
If you write a check from the IRA (Schwab and Fidelity offer check-writing privileges with their IRAs), and it doesn’t get cashed, then it would not be a distribution for the year in question. That could be a problem if you relied on the QCD to count toward your RMD for the year or if you were planning to make the maximum QCD next year. Ensure the charity has plenty of time to cash the check before December 31st. If you’re running late, have the check issued by your custodian and mailed to you so you can scan it for your records before forwarding it to the charity. This will ensure it is reported as a distribution on your 1099-R.
We also note that your custodian does not detail the donation on form 1099-R, which discloses IRA distributions. There is no unique code for a QCD. Keep good records and remember to pass on the information to your tax preparer, who will make the necessary adjustments to report it correctly (line 4b of Form 1040).
There’s a complex rule for people who make deductible IRA contributions after 70½. Essentially, these IRA contributions reduce your allowable tax-free QCD amount until they are used up.
In summary, the QCD is an important yet underutilized tool for optimizing taxes in retirement via a thoughtful, well-conceived spending strategy. If you’d like to know more about how a QCD might apply to your situation, schedule a call with one of our principals by clicking the "Book Now" button below.
This article was originally published on May 12, 2023
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