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Friday, January 29, 2021

Does a Qualified Charitable Distribution Make Sense This Year?

DOES A QUALIFIED CHARITABLE DISTRIBUTION MAKE SENSE THIS YEAR?

A unique provision in the tax code allows certain retirees to avoid tax on transfers made directly from a traditional IRA to a qualified charitable organization. Although one of the main attractions of a qualified charitable distribution (QCD) has been negated for 2020, there are still several viable reasons for making a QCD this year.

At the same time, charities that are in dire need of funding during the COVID-19 pandemic will greatly appreciate your generosity.

The back story

Normally, distributions from traditional IRAs are taxable at ordinary income tax rates, currently reaching as high as 37%. If you take money from an IRA and donate it to a qualified charity, it’s deductible on your annual tax return if you itemize deductions. Thus, these actions may cancel each other out. Non-itemizers who claim the standard deduction receive no tax benefit. (For 2020, a limited charitable deduction of up to $300 is available to non-itemizers.) 

With a QCD, you avoid the middleman. So long as certain requirements are met, the transfer isn’t treated as a taxable distribution. Thus, you won’t be taxed on the amount, but you can’t deduct the contribution, either.

To qualify for this special tax treatment, you must be at least 70½ years old at the time of the transfer. In addition, the maximum annual QCD allowed is $100,000 per taxpayer. A married couple can double this amount to $200,000.

Be aware that certain charities — including donor-advised funds, private foundations and supporting organizations — aren’t eligible to receive QCDs. Also, Roth IRAs may be used for QCDs, but there’s no advantage to it

But that’s not the end of the story.

Revised rules for RMDs

Significantly, a QCD also counts as a required minimum distribution (RMD) from an IRA. This is often cited as the main reason for arranging QCDs.

Participants in traditional IRAs must begin taking RMDs by April 1 of the year following the year in which they turn age 72. They must continue RMDs in each succeeding year. The RMDs are based on life expectancy tables and the value of the account on December 31 of the prior year.

Previously, the required beginning date (RBD) was based on age 70½, but the Setting Every Community Up for Retirement Enhancement (SECURE) Act pushed back the RBD, beginning in 2020. Thus, under the SECURE Act, you would normally have until April 1, 2021 to take your first RMD if you turned age 72 in 2020. 

The RMD rules also apply to beneficiaries who’ve inherited traditional IRAs. But mandatory lifetime distributions aren’t required for participants in Roth IRAs. (Roth IRA beneficiaries must empty out their account under special rules.)

The Coronavirus Aid, Relief and Economic Security (CARES) Act, with additional IRS guidance, suspends the RMD rules for 2020. Furthermore, this waiver extends to all beneficiaries of IRAs. So you don’t have to take any RMDs for 2020 if you don’t want to receive the money and don’t need it.

This change dilutes the benefits of using QCDs. In fact, some might even say there’s no reason to do it at all this year.

But there’s still more to the story.

Benefits of QCDs in 2020

Granted, a QCD won’t count as an RMD in 2020, because there’s no requirement to take distributions this year. However, there are other factors to consider.

For starters, taxpayers who’ve itemized in the past may now be claiming the standard deduction instead, due to numerous changes in the Tax Cuts and Jobs Act (TCJA) for 2018 through 2025. The TCJA reduced or eliminated several deductions. Using a QCD effectively “adds on” to the standard deduction.

Notably, a QCD reduces your adjusted gross income (AGI) for a variety of tax purposes. This has a domino effect on the rest of your return, including deductions and credits you may claim, alternative minimum tax (AMT) liability and imposition of the net investment income tax.

Also, if you’re receiving Social Security benefits, the benefits may be subject to tax under a complex formula. A QCD enables you to effectively lower your income for this calculation, thereby reducing another tax liability.

By taking funds out of your account at zero income tax cost, you may also be saving your family potential estate tax liability. The ability to make QCDs should be incorporated into your estate plan.

Icing on the cake

Finally, remember that QCDs benefit your favorite charities without a significant tax drain on your finances. The goodwill comes at a time when many organizations need the money more than ever before. Consider all the implications before you bypass a QCD this year.

SIDEBAR: ABCs of QCDs

How do qualified charitable distributions QCDs work? The funds must be transferred directly from your IRA custodian to the qualified charity. Arrange to have your IRA custodian issue a check from your IRA that’s payable to the charity. You can then request for the check to be mailed to the charity or you can do it yourself.

Conversely, if a distribution is payable to you, it doesn’t qualify as a QCD and will be treated as taxable income.


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