The ABCs of QCDs
If it sounds too go to be true, it probably
is isn’t. Are you age 70.5 or higher and have assets in an individual retirement account (IRA)? Do you have charitable intentions? Consider the use of a Qualified Charitable Distribution (QCD). It really is a great thing.
What is a QCD
A QCD is a transfer (processed by the custodian) from your IRA—typically in the form of a check—to a qualified charity. QCDs can be counted toward satisfying your required minimum distributions (RMDs) for the year. While many IRAs are eligible for QCDs—Traditional, Rollover, Inherited, SEP (inactive plans only), and SIMPLE (inactive plans only)—rules do apply:
- You must be 70½ or older to be eligible to make a QCD.
- QCDs are limited to the amount that would otherwise be taxed as ordinary income. This excludes non-deductible contributions.
- The maximum annual amount that can qualify for a QCD is $100,000. However, if you file taxes jointly, your spouse can also make a QCD from their IRA within the same tax year for up to $100,000.
- The charitable entity must receive the donation by December 31 in order to ensure credit to the proper year (I interpret this as the check should be cashed by this date).
Please note that the charity must be a 501(c)(3) organization to be eligible to receive tax-deductible contributions. Some charities that do not qualify for QCDs are:
- Private foundations.
- Supporting organizations: i.e., charities carrying out exempt purposes by supporting other exempt organizations, usually other public charities.
- Donor-advised funds, which public charities manage on behalf of organizations, families, or individuals.
History of QCDs
Congress first authorized the QCD in the Pension Protection Act in 2006. However, it only had a two-year life. It lapsed in 2008—only to be reinstated. This yo-yo continued in 2010, 2012, 2014. Finally, in late 2015 congress permanently reinstated QCDs.
This strategy was not extensively used in the financial planning community until 2018—following the passage of the Tax Cut and Jobs Act. Undoubtedly, the increased standard deduction—and suspension of personal exemptions meant that QCDs garnered increased attention. Indeed, it was estimated that roughly 90 percent of taxpayers would take the increased standard deduction. Of note, the TCJA increased the required minimum distribution (RMD) age to 72 but left the QCD age at 70.5.
Would I benefit from a QCD
One of the beautiful things about the QCD strategy is that it may benefit all taxpayers. Said otherwise, low-, middle-, and high-income taxpayers could utilize the strategy. Below are two examples.
Rose and Jack are expecting $160,000 in adjusted gross income (AGI) in 2022—$100,000 of which is the RMD from Jack’s IRA. Their itemized deductions total about $37,000; however, $24,000 of that is charitable donations.
|Without QCD||With QCD|
*$25,900 standard deduction plus $1,400 for each individual over 65
Rose and Jack make substantial gifts each year. By making those gifts using QCDs, they reduce their taxable income by $15,700, a tax savings of about $3,000.
Loren just turned 71 years old and has an IRA with a $152,000 account balance. His RMD for the current year is $5,750. If Loren does a $5,000 QCD to his favorite charity, it will satisfy $5,000 of his RMD obligation (without any tax liability), leaving him with only another $750 to distribute—which is income for tax purposes.
In addition to the examples detailed above, QCDs may reduce the impact to certain tax credits and deductions that are more specific to your personal situation. Consult with your tax professional and financial advisor to determine if any of these impacts you. Examples include:
- Reduce your modified adjusted gross income to avoid higher Medicare premiums.
- Tax filers with meaningful medical or dental expenses can use the QCD to increase their medical deduction.
- Utilizing the QCD to lower adjusted gross income below levels that can reduce the amount of investment income that is subject to the 3.8 percent Medicare tax.
- Tax filers who received social security and have limited other income sources can use the QCD to reduce or eliminate the amount of social security subject to taxation.
- Those who are constrained on the size of their charitable deduction can use the QCD to realize a larger tax benefit from their charitable giving.
For example, Edward and Vivian are expecting an adjusted gross income of $231,500 in 2022. In addition to their RMDs, which total $83,400, they receive social security, Edward has pension income, and the couple’s taxable investment portfolio produces both interest and dividend income.
Edward and Vivian give substantial amounts to charity each year. Therefore, they could donate after-tax dollars and still receive a tax deduction. However, their AGI makes them subject to surcharges on Medicare Part B and Medicare Part D premiums.
If Edward and Vivian donated their RMD to a qualified charity in the form of a QCD they reduce their AGI to $148,100. By lowering their AGI, they now avoid the income surcharge on their Medicare Parts B & D premiums—saving them thousands annually.
How to file taxes with a QCD
In my opinion, one of the most confusing aspects of the QCD comes when completing your tax return. Unfortunately, the guidance from the investment community and the IRS is lacking. To begin, your 1099-R form will show the distributed amount from your IRA for the calendar year. The 1099-R will essentially show the amount of your RMD for the year and offers no evidence to your accountant that you completed a QCD. Therefore, keeping detailed records of your QCDs is extremely important.
The process for indicating the QCD on IRS Form 1040 is almost as appalling. Below are the instructions from the IRS:
- If all or part of the distribution is a qualified charitable distribution (QCD), enter the total distribution on line 4a.
- If the total amount distributed is a QCD, enter -0- on line 4b. If only part of the distribution is a QCD, enter the part that is not a QCD on line 4b.
- Enter “QCD” next to line 4b.
A QCD is only one of several approaches for those who are charitably inclined. Importantly, your amount of charitable giving is a personal decision that should not be determined or driven by potential tax savings. The intent here is to expand awareness on what the QCD is, how it works, and how you might benefit from its use. Work with your accountant and financial advisor to take a comprehensive look at your situation in the context of your overall financial situation.
While we are familiar with the tax provisions of the issues presented herein, as Financial Advisors of RJFS, we are not qualified to render advice on tax or legal matters. You should discuss tax or legal matters with the appropriate professional.