Understanding Qualified Charitable Distributions (QCDs)
Don’t make the loss of a tax deduction your reason for not giving
Charitable giving stems from an intrinsic desire to express support for causes that are dear to one’s heart. The U.S. government recognizes the social benefit of charitable giving, as such, the tax code provides a tax deduction that ultimately reduces the givers’ taxable income. While most people don’t give solely to obtain a tax deduction, they may be inclined to give more because of the added incentive the tax deduction provides. The Tax Cuts and Jobs Act of 2017 nearly doubled the standard deduction. The increased standard deduction will result in fewer people itemizing their deductions, which includes the charitable giving deduction. Therefore, there is no tax benefit for charitable contributions for taxpayers utilizing the standard deduction. While many people will still give, some may be compelled to give less.
A question many people have is this: is there a way I can continue to support my charitable causes and still receive a tax benefit? We believe qualified charitable distributions (QCDs) may be the answer for some.
What is a Qualified Charitable Distribution?
A brief history: QCDs have been around since 2006 but were made permanent in 2015 with the passing of the Protecting Americans from Tax Hikes Act (PATH). Under the new tax law, they’ve garnered a new gleam with their tax-efficient ability to foster giving.
A QCD allows individuals 70 ½ years or older to transfer money directly from an IRA to a qualified charity without increasing your taxable income or AGI. Up to $100,000 can be donated through a QCD each year. QCDs can be used to satisfy required minimum distributions (RMDs). This is beneficial, as it keeps your AGI low which can consequently reduce the amount of social security that’s taxed and can even impact your Medicare premium. The QCD strategy of directing money from an IRA to a charity would allow you to avoid taxes that a withdrawal might otherwise incur.
As an example, let’s say you have a social security income of $50,000, pension income of $20,000, dividend interest of $5,000, and an IRA distribution of $20,000, from which $10,000 goes toward charitable donations. In this situation, up to 85% of your social security income is taxable and the charitable contribution has no taxable benefit. If instead, the $10,000 charitable contribution was processed as a QCD, social security would be taxed between 50-85% and only $10,000 of the IRA distribution would be taxed as ordinary income. Further, if the same numbers applied to a single tax filer, the QCD would eliminate a Medicare surcharge of approximately $50 per month.
Are you eligible to take advantage of a QCD? Here are the guidelines:
- You must be 70 ½ or older on the date of distribution.
- “For the QCD to satisfy the current year required minimum distribution (RMD), the distribution must be completed by December 31st.
- You can donate up to $100,000 per person per year.
- The money must be transferred directly to the charity from the IRA.
- The distribution is not taxable, but you will get a 1099 and need to report it on your tax return.
- Your charity of choice must be a 501c3 organization. This means you cannot donate to a foundation you’ve set up or a Donor Advised Fund (DAF).
Donor Advised Funds and Other Strategies
If QCD doesn’t work for you, another tax-savings strategy to consider is a Donor Advised Fund (DAF). A DAF is a vehicle for charitable giving that allows you to make contributions for immediate tax benefit, and then grant the the funds to charities over time.
For example, if you typically give $5,000 throughout the year, establish a Donor Advised Fund with $30,000 for future years’ giving. With a DAF, you can take an itemized deduction in the first year, followed by standard deductions in subsequent years, thereby maximizing your tax deductions over time. Establishing a DAF with highly appreciated assets from your investment portfolio also allows you to avoid the capital gains, providing an additional tax-savings opportunity.
For many, QCDs’ exclusion from taxable income (or AGI) altogether may offset the benefit once provided by itemized deductions. To ensure you implement a QCD, DAF or other charitable gifting strategy properly—and to ensure you don’t miss out on other potential tax advantages—we recommend working with a qualified tax advisor or financial planner. While we never anticipate giving solely for the sake of tax breaks, we know that gifting in a tax-effective manner can allow you to give more freely, and on your own terms.