Tax-Savvy Charitable Giving Part 1: Qualified Charitable Distributions
Americans gave $499.3 Billion to charity last year, and individuals (not corporations) made up the lion’s share of those donations.
Now, as much as we’d love for this stat to be 100% altruistic, we have to admit that, for most of us, “is this going to be a tax deduction?” runs through our heads as we write the donation check.
Historically, charitable donations have been a great way to do a good deed, while also receiving a bit of a personal benefit through a tax deduction. However, since the tax reform that took place in 2018, that personal reward has been harder to come by.
Why is that?
Well, in short, when you’re filing your taxes, you have a choice: take the standard deduction, or itemize your deductions. You only itemize if your individual deductions will be higher than the standard deduction that the IRS allows everyone to take.
Charitable contributions fall into the itemized deduction category. Therefore, when the standard deduction doubled in 2018, it made sense for less people to itemize, and therefore charitable gifts didn’t hold the same weight that they used to.
That being said, just because it’s more difficult to get a tax benefit from your giving doesn’t mean all hope is lost. There are a few strategies that offer compelling ways to give, while getting a little bit back in return.
One particular method that stands out for its advantageous tax implications is utilizing Qualified Charitable Distributions (QCDs). Understanding and harnessing the power of QCDs can significantly impact your tax liabilities while supporting charitable organizations.
What are Qualified Charitable Distributions?
A Qualified Charitable Distribution is a direct transfer of funds from your Individual Retirement Account (IRA) to an eligible charity. It's a strategy available to individuals who are aged 70½ or older, allowing them to donate up to $100,000 per year directly from their IRAs to qualified charitable organizations. This distribution is excluded from the taxpayer's income, offering a distinct advantage over other forms of charitable donations.
Tax Benefits of QCDs
The primary advantage of a QCD is that the gift comes straight out of your Traditional IRA without counting as income.
When you have a traditional IRA or any other tax-deferred retirement account, you are required to start taking distributions when you turn 73 (or 75 depending on when you were born). These distributions are taxable to you as income, and have the potential to push you into higher tax brackets.
For federal retirees, it’s extremely common to see someone who has enough income from their pension and social security to live on comfortably. Then Required Minimum Distributions (RMD) start at 73 and all of a sudden they’re required to pay taxes on income that they don’t really need.
When you make charitable donations through a QCD, the donated amount is not counted as income, but it does count toward your RMD. In other words, you can satisfy your RMD requirements without raising your gross income (AGI), and help out a charity in the process.
This reduction in AGI may result in several tax benefits, such as potentially reducing the tax on Social Security benefits, minimizing Medicare premiums, and lowering the impact of phase-outs for certain deductions and credits.
Moreover, for those who take the standard deduction rather than itemizing, utilizing QCDs can be particularly advantageous. By using a QCD, individuals can support charities while still enjoying the benefits of the standard deduction, as the donated amount doesn't count as an itemized deduction.
If you’ve been taking distributions from a Traditional IRA and then giving to charities from your bank account, you should strongly consider using QCDs.
Qualifying Criteria and Considerations
To ensure that your charitable distributions qualify for these tax advantages, it's crucial to adhere to certain criteria:
Age Requirement: As mentioned earlier, individuals must be aged 70½ or older at the time of the donation.
Eligible Charities: QCDs must be made directly to eligible 501(c)(3) charities, private operating foundations, and certain religious organizations.
Funds must be transferred directly from the IRA: A distribution taken in your own name, and then paid to the charity will not qualify.
Limitations: The maximum annual limit for QCDs is $100,000 per taxpayer. Amounts exceeding this limit aren't eligible for the exclusion from income.
No Deductions for QCDs: The benefit of a QCD is that it doesn’t count towards your income like a normal distribution would. This means you don’t get to additionally include it as an itemized deduction on your taxes.
How to Execute a QCD
Executing a Qualified Charitable Distribution involves several steps:
Consultation: Seek advice from a financial advisor or tax professional who can guide you through the process and ensure compliance with IRS regulations.
IRA Distribution: Instruct your IRA custodian to transfer the desired donation amount directly to the eligible charitable organization.
Documentation: Keep records of the donation, ensuring that the charity acknowledges the QCD for tax purposes.
Bob is 75 years old in 2023 and needs to take an RMD from his traditional IRA. Bob’s traditional IRA is valued at $1,050,500, resulting in a projected RMD of $42,683. His ordinary income in 2023 is $80,000 and he will submit tax returns with the single filing status.
Bob’s adjusted gross income (AGI) is projected to be $80,000, but if he takes his RMD income of $42,683, it will increase his AGI to $122,683. If Bob then donates his RMD to charity, he would take an itemized deduction of $42,683, assuming he has no other deductions to itemize. This results in $80,000 in federal taxable income.
However, if Bob instructs his IRA administrator to direct his RMD as a QCD to an eligible charity, the RMD would be excluded from Bob’s taxable income. Bob then takes the standard deduction of $13,850 for 2023, plus an additional standard deduction of $1,850 because Bob is over 65 and has a single filing status. Therefore, his standard deduction totals $15,700. As a result, his federal taxable income is reduced to $64,300.
Utilizing Qualified Charitable Distributions presents a powerful opportunity to support charitable causes while optimizing your tax situation. By leveraging this strategy, eligible individuals can contribute meaningfully to charitable organizations while benefiting from potential tax savings. However, it's crucial to seek professional advice and ensure compliance with IRS regulations when executing QCDs. Consider exploring this tax-savvy charitable giving option to both support causes you care about and strategically manage your tax liabilities.
Giving USA 2021 Annual Report
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual.
This information is not intended to be a substitute for individualized tax advice. We suggest that you discuss your specific tax situation with a qualified tax advisor.