Prior to 2015, Congress created a temporary rule – called the qualified charitable distribution rule – each year allowing traditional IRA owners to exclude their required minimum distributions from their adjusted gross income and reduce their taxes if they transferred this amount to a qualified charitable organization. However, the impermanence of this rule made future tax planning difficult for investors.
In late 2015, Congress finally made this charitable provision permanent, thus allowing taxpayers to create long-term planning strategies around this rule.
Who Is Able to Reduce Taxes With QCD Rule
Any traditional IRA owner or beneficiary who is at least 70.5 years old can use the qualified charitable distribution (QCD) rule to exempt their required minimum distributions (RMDs) from taxation. The age limit here applies to the exact date on which the IRA owner turns age 70.5. For example, if an IRA owner turns 70 on February 15, he or she cannot make a QCD until August 15.
Roth IRA owners are also allowed to use the QCD rule, although they will not see any benefit from doing so as their distributions are already tax-free.
All contributions and earnings that accumulate inside a traditional IRA are eligible for QCDs. The exception is nondeductible contributions, as they are considered a tax-free return of basis. The amount that can be taken as a QCD is capped at $100,000 per taxpayer per year. Joint gifting strategies are also not available for the purpose of QCDs, meaning a couple cannot take both of their aggregate RMD amounts from a single account and exclude the entire amount from their adjusted gross income (AGI). Each of them must take their RMD from their own accounts for both to qualify.
The QCD strategy can also benefit traditional IRA owners who want to convert their balances to Roth accounts, as the QCD will reduce the amount of taxable money in the account. (For related reading, see: Tips on Charitable Contributions: Limits and Taxes.)
The AGI Advantage
One of the biggest advantages the QCD rule provides is the ability for taxpayers to lower their AGI. This is much more valuable than taking an itemized deduction, which merely lowers taxable income. Because AGI is used for many tax calculations, having a lower number can allow the donor to stay in a lower tax bracket, reduce or eliminate the taxation of Social Security or other income, and remain eligible for deductions and credits that might be lost if the taxpayer had to declare the RMD amount as income. (For related reading, see: How to Calculate AGI for Tax Purposes.)
The main rule to remember when it comes to QCDs is the distributions must be made directly to the charity, not to the owner or beneficiary. Distribution checks need to be made payable to the charity or it will be counted as a taxable distribution. The owner or beneficiary can receive this check and deliver it to the charity, but he or she cannot deposit the check and make out another one to the charity. (For related reading, see: Donations: How to Maximize Your Tax Deduction.)
Of course, any distributions in excess of $100,000 can still be contributed to charity, but they will not be excluded from AGI, and the taxpayer must qualify for itemized deductions to deduct the excess contribution. The receiving charity must also be a qualified 501(c)3 organization – vehicles such as charitable gift annuities will not qualify.
The donation amount must also be substantiated by the charity with a written receipt.
The Bottom Line
IRA owners who wish to lower their AGI can use the qualified charitable distribution strategy to efficiently disperse money to a charity of their choice. This strategy is superior to taking constructive receipt of the distribution and then donating to charity because the second option will not reduce the donor’s AGI. This rule, which is now permanent, will provide charitably minded IRA owners with a convenient tax deduction for years to come.
(For related reading, see: Top Tips to Reduce Required Minimum Distributions.)