Following the passage of the Tax Cuts and Jobs Act in December 2017, the law’s impact on charitable organizations has come to the fore. Although the law provides for an increase in cash gifts to public charities from 50% of the donor’s adjusted gross income (AGI) to 60% of AGI, the donor must itemize their deductions to realize a tax benefit for their gift. The new law’s increase in the standard deduction to $12,000 for single filers and $24,000 for married couples filing a joint return is expected to result in a sharp reduction in the number of households that itemize their deductions, reducing the marginal tax benefit of gifts to charity by more than 25%. The impact of the law on charities remains to be seen, but with an estimated 72% of charitable gifts coming from individual donors it may be profound. Fortunately, the Protecting Americans from Tax Hikes (PATH) Act of 2015 has made permanent a hitherto underutilized incentive for older Americans to give to charity. The Qualified Charitable Deduction (QCD) is in vogue once again.
What is a QCD?
A Qualified Charitable Distribution is a transfer of funds from an Individual Retirement Account (IRA) made payable directly to a qualifying charity. If done correctly, the transfer will satisfy the account owner’s required minimum distribution (RMD) and is excluded from their taxable income. In effect, the taxpayer can provide a gift to charity using pre-tax money from their IRA. And while the gift is not eligible to be used as an itemized deduction- that would be to claim the gift twice- it may provide an elegant solution to those charitably-inclined taxpayers that are unlikely to itemize their deductions as a result of the new tax law.
History of the QCD:
The rules that allow for the QCD were first established in the Pension Protection Act of 2006 as a temporary provision that was effective for 2006 and 2007. It was subsequently reinstated as part of the Emergency Economic Stabilization Act of 2008, only to lapse and be reinstated in 2010, 2012, 2014 and retroactively in 2015 with the passage of the Act. Given the law’s on again, off again existence and stringent rules, it has been an often overlooked or unavailable option. The 2015 Act finally made the QCD permanent.
Benefits & Planning Opportunities:
A primary benefit of the QCD is that it omits from taxable income an IRA distribution that would otherwise have been fully taxable. This is very important and presents a wide array of planning opportunities.
- Taxpayers that are not eligible to itemize their deductions as a result of the new tax law can continue to make charitable donations and receive a tax benefit. Absent the QCD, donors would take their RMD, donate the amount to a charity and claim a charitable contribution to offset the income. This offset is sometimes, but not always, dollar for dollar. In contrast, the QCD provides an offset to income of the entire donation. This simple and effective technique provides seniors with a powerful incentive to give.
- Single individuals with more than $85,000 of modified adjusted gross income (MAGI) and married couples filing a joint return with over $170,000 of MAGI may avoid the Medicare Income-Related Monthly Adjustment Amount (IRMAA), an extra premium paid by those with higher incomes.
- Single individuals with more than $200,000 of adjusted grow income (AGI) and married couples filing a joint return with more than $250,000 of AGI can use the QCD to help reduce or avoid the 3.8% Additional Medicare Tax.
- Social Security benefits may be taxed at a lower rate. This benefit would extend primarily to those with a more modest level of taxable income.
- Those with qualifying medical or dental expenses that exceed 7.5% of their AGI can use the QCD to reduce their income to capture more value from the deduction. It’s important to note that the 7.5% threshold will increase to 10% of AGI beginning in 2019.
Although simple and effective, the QCD does have a number of rules that must be strictly followed. Failure to do so will result in the distribution becoming fully taxable.
- The owner of the IRA must be 70 ½ years of age at the time of the distribution. Beneficiaries of an inherited IRA (often the adult child of the decedent) may also utilize the QCD strategy so long as they (not the original account owner) have attained age 70 ½.
- The donation must go a public charity under IRC Section 170. Thus, donations to a private foundation or donor-advised funds are not allowed.
- A donation must have otherwise been fully deductible to qualify. In a case where the donor receives an item of value in return for their donation, the gift is not eligible to be treated as a QCD.
- The distribution must come from an IRA, including inactive SEP and SIMPLE IRAs. Donations from a 401(k), 403(b), and SEP or SIMPLE IRAs receiving employer contributions are not eligible.
- The maximum amount that will qualify for a QCD is $100,000 per individual. IRA distributions from accounts that include post-tax contributions are allowed, and the IRS will use the ordering rules of IRC Section 408, which require that pre-tax contributions be counted first for purposes of a QCD. IRA accounts with only after-tax contributions are not eligible for a QCD.
- The QCD may exceed the amount of your RMD for a given year, but cannot exceed the $100,000 limit. Excess amounts cannot be used to satisfy future RMDs.
- Taxes should not be withheld on a QCD. If the rules are followed, it will not be treated as a taxable distribution.
- The check must be made payable to the charity (not the account owner). The check may be sent to the account owner and forwarded to the charity for deposit. A check made payable to the account owner and endorsed to the charity will be treated as a fully taxable distribution.
- It is suggested that the charity receive and deposit the funds by December 31st of the tax year. This evidences constructive receipt of the donation.
- Donors should receive an acknowledgment of their donation from the charity. This must be retained for tax reporting.
The potential reach of the QCD is enormous and will increase as the baby boom generation enters retirement. This relatively simple strategy combines generous annual limits and tax benefits for low, middle and high- income taxpayers, and could prove to be a boon to charitable organizations.
John Male, CFP®, RICP®
The Gassman Financial Group
The Retirement Maven™
9 East 40th Street
New York, NY 10016