After your retirement, or if you’re retiring soon, you may be more inclined to make donations to your charity. However, you may receive little or no tax benefit from your contribution, depending on whether you itemize deductions. As a result, you might rely on a provision in the tax code to achieve your charitable intentions. With this technique, you arrange to transfer qualified charitable distributions (QCDs) directly from an IRA to a qualified charitable organization.
IRA distributions
In the normal course of events, distributions from a traditional IRA are taxed at federal income tax rates topping out at 37%. The distributions can also cause net investment income tax (NIIT) complications. Therefore, retirees may decide to postpone IRA distributions if federal law prohibits.
Of course, if you take distributions from an IRA and contribute the money to a charity, you may claim a deduction for the monetary contribution if you itemize deductions. In effect, at best the contribution can offset the taxable income. But recent tax legislation has increased the incentive to claim the standard deduction instead of itemizing. So fewer taxpayers are choosing to go this route.
If you didn’t itemize deductions in 2021, you were allowed a limited charitable deduction of up to $300 ($600 for joint filers). This tax break hasn’t been extended for 2022. Current tax law creates an opportunity for certain older individuals to include QCDs in their estate plans.
QCDs in action
By using QCDs, you avoid the “middleman” for a transfer of IRA funds to charity. In other words, the money goes directly from your IRA to the organization. It never touches your hands. You must make the necessary arrangements with your IRA custodian.
The payoff: As long as certain requirements are met, the transfer isn’t treated as a taxable distribution subject to federal income tax. Conversely, you can’t deduct the contribution either, even if you itemize. Essentially, it’s a “wash” for federal income tax purposes.
To qualify for this tax treatment, you must be at least 70½ years old at the time of the transfer. In addition, the maximum annual QCD allowed under law is $100,000 per taxpayer. A married couple can double this amount to $200,000 if each spouse qualifies and contributes the full amount.
Be aware that certain charities — including donor-advised funds, private foundations and supporting organizations — aren’t eligible to receive QCDs. Roth IRAs may be used for QCDs, but there’s no advantage to doing this because Roths are designed to provide tax-free income in the future.
How QCDs affect RMDs
Notably, a QCD satisfies the rules for required minimum distribution (RMD) from traditional IRAs. This is often cited as one of the main reasons for arranging QCDs — if not the sole reason.
With a traditional IRA, you must begin taking RMDs by April 1 of the year following the year in which you turn age 72. Then you must continue to take RMDs in each succeeding year. The RMDs are based on life expectancy tables from the IRS and the value of the account on December 31 of the prior year.
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 accounts under special rules.)
Other tax-related considerations
Be aware that a QCD reduces your adjusted gross income (AGI) for various other tax purposes. This can have a domino effect on the rest of your tax return, including deductions and credits you may claim, alternative minimum tax (AMT) liability and imposition of the NIIT. Also, if you’re receiving Social Security benefits, the benefits are subject to tax under a complex formula. A QCD enables you to effectively lower your income for this calculation, thereby reducing another tax liability.
Is a QCD the right move for you? Turn to your estate planning advisor for the answers.