For those over age 70 1/2, a qualified charitable distribution (QCD) is a great way to make a charitable donation in a tax-efficient manner. Beginning in 2018, many individuals and families will lose out on the ability to fully deduct charitable donations as an itemized deduction. This is due to the doubling of the standard deduction, as well as the limitation of many itemized deductions as part of the Tax Cuts and Jobs Act of 2017.
For these reasons, a qualified charitable distribution should be a consideration for those wanting to make the most of their charitable donations.
What is a Qualified Charitable Distribution?
Per IRS Publication 590-B, “A qualified charitable distribution (QCD) is generally a nontaxable distribution made directly by the trustee of your IRA (other than a SEP or Simple IRA) to an organization eligible to receive tax deductible contributions. You must be at least age 70 1/2 when the distribution was made. Also, you must have the same type of acknowledgment of your contribution that you would need to claim a deduction for a charitable contribution.” (For more, see: How to Use the QCD Rule to Reduce Your Taxes.)
What is the Benefit of a QCD?
Taxpayers are able to use the qualified charitable distribution to satisfy part or all of their required minimum distribution (RMD) from their tax-deferred retirement accounts. Using the qualified charitable distribution to satisfy part or all of an RMD can allow a taxpayer to satisfy their RMD with less of a tax impact.
For example, if an RMD was $50,000 for 2018, and a taxpayer made a $20,000 nontaxable qualified charitable distribution, they would only need to make an additional $30,000 IRA distribution to satisfy their RMD, thus reducing the taxable income from their RMD from $50,000 to $30,000.
Rather than claiming the charitable donation as an itemized deduction, the qualified charitable donation reduces the taxpayers adjusted gross income. Why is this important? The benefit of not including the donation as income could prevent an increase in Social Security taxation, an increase in Medicare premiums or a reduction in deductible medical expenses, which is based on a percentage of the taxpayers adjusted gross income.
Furthermore, many taxpayers have lost the ability to fully deduct charitable contributions as an itemized deduction. Taxpayers in this situation are able to use the qualified charitable distribution to make a charitable donation in a tax-favorable manner, whereas they would not be able to claim a tax deduction otherwise. (For related reading, see: Tips on Charitable Contributions: Limits and Taxes.)
How to Make a Qualified Charitable Distribution
Here is a list of considerations for making a qualified charitable distribution:
- You must be at least 70 1/2 years old at the time of the qualified charitable distribution. If you request the qualified charitable distribution prior to age 70 1/2, it is not a qualified charitable distribution and will be taxed as income. There are no exceptions to this rule.
- You can make a qualified charitable distribution from the following: traditional IRA, inactive Simple or SEP IRA (inactive meaning that they are not receiving ongoing contributions), or an inherited IRA. However, keep in mind that you must be over age 70 1/2.
- The qualified charitable distribution must go to a public charity. Donor-advised funds, private foundations and supporting organizations are among the charities that are not eligible.
- Funds must be transferred directly from your IRA custodian and payable to the qualified charity. The check cannot be made payable to the IRA owner. You can make up to $100,000 a year of qualified charitable distributions per person.
- The qualified charitable distribution must occur before December 31 of the current year to be applicable in the current tax year.
- You must self-report the qualified charitable distribution on your income tax return. Your custodian does not report to the IRS that a qualified charitable distribution has been made.
- Ensure that no taxes are being withheld, as this money does not go to a qualified charity and will be treated as a taxable distribution.
This is a brief overview of the benefits and considerations of a qualified charitable distribution. Because there may be other considerations, I recommend working with your financial planner and tax professional to determine if this is the best strategy for you and navigate the stringent requirements to avoid complications. (For more from this author, see: What Are the Benefits of a Donor Advised Fund?)