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Maximize Tax Benefits with a Qualified Charitable Distribution

Logan Baker

Lead, Senior Wealth Strategist

Bryan Strike, MS, MTx, CFA, CFP®, CPA, PFS, CIPM, RICP®

Director, Financial Planning Research & Education

Summary

The qualified charitable distribution has become popular with some IRA holders as a way of donating to charities while saving money on taxes.

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The Pension Protection Act established the qualified charitable distribution (QCD) into law in 2006. The original provision was temporary and required reauthorization by Congress every year, until the Protecting Americans from Tax Hikes (PATH) Act of 2015 made it a permanent part of the Internal Revenue Code. Since then, the QCD has become a popular way for certain taxpayers who have an individual retirement account (IRA) to reach their charitable goals while saving money on taxes.

 

What is a QCD, and who is eligible?

A QCD is a direct transfer of IRA assets to an eligible public charity by a taxpayer who is age 70½ years or older. The maximum annual limit is currently $100,000, which will be adjusted for inflation beginning in 2024, and this distribution can count against the taxpayer’s required minimum distribution (RMD) amount, if any, for the year it’s taken. Under current rules, IRA holders are required to begin taking distributions at age 73, and the amount depends on both their age and account balance at the end of the prior year.

A proper QCD transaction has three main components: (1) age of the donor, (2) direct transfer of assets from an IRA to a charity, and (3) eligibility of the charity. Some charitable deductions under the normal tax rules are not allowable under the rules for a QCD, including the deductions for a donor advised fund (DAF), private foundation, and “supporting organization” as defined in the tax code.[1] You can search for qualified organizations here.

 

What’s the benefit?

Charitable contributions are typically an itemized deduction in Schedule A of an income tax return. Taxpayers usually claim the higher of either the allowable standard deduction or their total itemized deductions, such as medical expenses, home mortgage interest, and charitable donations. With the passage of the Tax Cuts and Jobs Act of 2017, the standard deduction amount practically doubled while the number of allowable itemized deductions shrank, making it much more difficult to reap a tax benefit by giving. For some people, however, it’s possible to donate directly from an IRA and save on taxes, even without itemizing deductions.

Distributions from an IRA are generally treated as ordinary income for tax purposes. A proper QCD, however, is a tax-free transfer of IRA funds to a charity. By taking a deduction when calculating adjusted gross income (AGI), the taxpayer can benefit regardless of their itemized deductions. But since the taxpayer gets the benefit of a tax-free distribution, they can’t also include the donation as an itemized deduction.

 

How to initiate a QCD transfer

Most brokerage firms that offer IRAs can establish a QCD. Transfers can usually be set up electronically through the firm’s website. A payment can be made one time or over a period of time (e.g., monthly). Some firms have recently included check-writing privileges with a customer account, including IRA, which can help in making a transfer. Note, however, that if a distribution check is payable to the taxpayer and not to a charity, it will not count as a QCD and will be subject to income tax.

A note of caution: To count against the taxpayer’s current-year RMD, a check must be cashed before year-end. Just writing the check and mailing it to a charity isn’t always enough. Consider sending the check no later than early December.

 

Which accounts qualify?

Traditional IRA and inherited traditional IRA are commonly used for a QCD. SEP IRA and SIMPLE IRA are also eligible if the plan is no longer active and receiving employer contributions. Remember—even with an inherited IRA, the beneficiary-owner must be age 70½ or older to qualify.

Example: Marge inherited an IRA from her father last year. Since she’s 63 years old, she can’t perform a QCD with either her own IRA or the inherited IRA.

 

First-dollars-out rule affects QCD and RMD

Tax rules state that the first dollars withdrawn from an IRA in a year when the taxpayer has an RMD due will go to satisfy the RMD. This is an important distinction for taxpayers who want to utilize a QCD to satisfy some or all of their RMD for the year. A person generally should make any distribution for the year as a QCD before taking a distribution for themself, if they want the full tax benefit.

Example: Jennifer has an RMD of $10,000 for the year. In January, she takes $6,000 to cover a medical emergency that occurred in December. Later in the year, she donates $10,000 as a QCD to her favorite charity. Since $6,000 of her RMD has already been spent, only $4,000 (i.e., the remaining RMD amount) of the QCD counts against the year’s RMD.

 

Properly treating a QCD in a tax return

If a taxpayer performs a QCD transaction, it’s imperative that they maintain records of when the distribution occurred and the name of the recipient charity. The IRA custodian will issue a Form 1099-R early in the following year that states the total amount distributed from the IRA without mention of the QCD.

It’s entirely the taxpayer’s responsibility to correctly file their Form 1040 indicating the total distribution, per the 1099-R, in line 4a. Line 4b should include the total distribution less any amount attributed to the QCD or distributed from the IRA. In addition, the acronym “QCD” should appear next to line 4b.

 

Be careful with QCD and state tax credits

While a well-timed QCD can help with federal income tax, many states also provide tax credits for charitable donations made to qualifying charities that support residents, organizations, or interests of that state. For example, Arizona provides an income tax credit for donations to a charity that aids Arizona residents who receive Temporary Assistance for Needy Families (TANF) benefits, people with low incomes, and children with a chronic illness or disability. Taxpayers claim the credit on their state income tax return in the year of the donation. Review your state’s specific rules to see if this applies to you. A high-level summary can be found here.

While receiving both a federal tax deduction and a state tax credit might be enticing, it can create the unintended consequence of disallowing some or all of the charitable deduction. For example, a charitable deduction disallowance can happen when the charity provides a benefit in return (i.e., quid pro quo). This frequently occurs when a donation to one’s alma mater results in preferential parking, paid membership, or a discount for sports tickets. Silent auctions also create some element of quid pro quo, as the winning bidder receives an item of value such as a painting, trip, or hotel accommodations. In these situations, the donation in excess of the return benefit qualifies as a charitable deduction for standard donations.

Example: James donates $1,000 to his college and receives a $300 reduction in the price of sports tickets for the season. James would be allowed an itemized deduction of $700 in the year the gift was made.

For a QCD, any disallowed federal deduction will lead to the loss of QCD treatment for the entire gift. Under IRS regulations finalized in 2019, the value of any state income tax credit received in connection with a charitable donation is treated as an economic benefit to the taxpayer, thus requiring the taxpayer to reduce the deductible amount of their donation. In the QCD context, this means the QCD is not an otherwise fully deductible donation, the entire amount is disqualified for QCD treatment, and the distribution is recharacterized as taxable income for the account owner.

Example: James’ older brother Tom donates $1,000 directly from his IRA to his college in an otherwise allowable QCD transaction. He receives a $300 reduction in the price of sports tickets for the season. This quid pro quo invalidates the entire QCD transaction, causing the $1,000 to become taxable income for Tom, who is allowed a $700 itemized deduction.

The rules do provide relief for state tax credits of 15% or less, and provide that the full amount of a donation will qualify as deductible at the federal level. In other words, a QCD is allowed as long as the value of the state tax credit is no more than 15% of the value of the QCD. State income tax deductions, even up to 100% of the donated amount, qualify as deductible at the federal level as well.

While federal and state laws generally favor charities, and charitable giving can have nice tax benefits, figuring out how to donate can be complicated and often depends on a person’s situation. For those age 70½ and older who have a qualifying IRA, a QCD can make sense for fulfilling an RMD requirement while using a tax-advantaged way of giving to a charity of choice. Whether it’s right for you depends on many factors, and that’s why it’s important to work with your advisor to develop the right approach for your needs.

1 IRC §408(d)(8)(B)(i); IRC §4966(d)(2); and IRC §509(a)(3)
2 IRC §170
3 IRC §408(d)(8)
4 IRC §408(d)(8)(D)
5 Treasury Regulation §1.408-8 Q&A 4
6 IRC §408(d)(8)(A)(i)
7 IRC §408(d)(8)(A)(i) specifies that those contributions deductible under §219 create the “rejected QCD” problem.  Qualified retirement plans, SEP IRAs, and SIMPLE IRAs, receive their deductibility under §404.
8 IRS Notice 2018-54 and https://www.federalregister.gov/documents/2019/06/13/2019-12418/contributions-in-exchange-for-state-or-local-tax-credits
9 IRC §408(d)(8)(C)

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