By Cristina Wiebelt-Smith, CPA, Wealth Planning Administrator
There is a simple but powerful tool called a qualified charitable distribution (QCD) that is a triple threat. They can fulfill your required minimum distribution (RMD), benefit your favorite charities, and reduce your taxable income. A QCD allows you to donate up to $100,000 of your RMD (pulling money from your taxable income) to qualified charitable organizations each year.
All you need to do is instruct your IRA custodian to write a check to a qualified 501(c)(3) organization instead of distributing the money to you. You’ll have more control over your taxable income, and it can result in tax savings.
Let’s look at two potential scenarios – one in which you use a QCD and one in which you don’t.
RMDs without using a QCD:
You have an RMD of $20,000 per year. You’re in the 22% tax bracket and have a 6% state tax rate. You take the standard deduction. You receive $20,000 in cash, you give $10,000 to your charity, and the entire RMD of $20,000 is taxable to you. The net result is that you end up with approximately $4,000 after the donation and federal and state taxes.
RMDs using a QCD:
It’s the same situation as above, but you tell your IRA custodian to use a QCD to donate $10,000 to the charity. You receive $10,000 in cash, the charity still gets $10,000 and only $10,000 of the RMD is taxable to you. Due to tax savings, you end up with approximately $7,000 after the donation and federal and state taxes. The QCD allows you to accomplish your charitable giving and leaves you with an additional $3,000. And you may end up with additional tax savings beyond the $3,000 because a QCD also lowers your adjusted gross income (AGI).
We based the earlier example on a $20,000 RMD. Think of the possibilities if your RMD is $50,000 or 100,000. You can accomplish the same charitable giving, fulfill your RMD, and gain more control over the amount and timing of your taxable income.
The Power of Lowering Your AGI
Lowering your AGI is powerful because it determines the eligibility and limitations on many tax deductions and credits. The lower your AGI, the more deductions and credits you may be eligible for, such as the qualified business income deduction or medical expense deduction. In addition, your AGI affects other items such as how much of your Social Security is taxed, whether you’re subject to the 2.5% investment income tax, your Medicare premium cost and most recently, the COVID-19 stimulus checks.
The beauty of a QCD is that you can reap these tax benefits without itemizing. The number of people who itemize has drastically decreased over the past few years due to the recent increase in the standard deduction. When you take the standard deduction, you don’t receive a deduction for your charitable donations so a QCD is a way to regain some of that tax benefit. Even if you itemize, a QCD may be the more beneficial way to go because of the benefits a lower AGI can create.
Rules and Limitations that Help Define QCDs
- The maximum amount that can qualify as a QCD is $100,000.
- If you are married and file a joint return with your spouse, you and your spouse can each make $100,000 QCDs from your IRAs for a total of $200,000
- Your QCD can be more than your RMD, but it will not count toward the following year’s RMD. For example, your RMD is $50,000 but you want to give $75,000 to charity. You take a $75,000 distribution as a QCD and the entire amount is excluded from your taxable income, but that additional $25,000 does not fulfill your RMD for next year.
- For the QCD to count toward your current year’s RMD, the funds must come out of your IRA by your RMD deadline, generally December 31.
- The funds must be transferred directly from your IRA to the qualified charity – do not stop, do not pass go. If a check is made payable to you, and you give to a qualified charity, it is not a QCD.
- You can write one check for up to $100,000 to one qualified charity or spread the love and split up to $100,000 among several qualified charities.
- Certain charities are not eligible to receive QCDs, including donor-advised funds, private foundations, supporting organizations and anything that benefits you directly.
- The QCD is reported by the IRA custodian as a normal distribution on Form 1099-R with no indication that it is not taxable. Therefore, hold on to your documentation and make sure you communicate with your tax preparer, so it is handled correctly.
If you have an RMD, and you also donate to 501(c)(3) organizations, ask your advisor about a QCD.
This blog is not intended to provide specific legal, tax, or other professional advice. For a comprehensive review of your personal situation, always consult with a tax or legal advisor. The hypothetical investment results are for illustrative purposes only and should not be deemed a representation of past or future results.