Prior to the enactment of Qualified Charitable Distributions (QCD), you were able to make a normal distribution from your IRA and contribute the cash to a qualified charity. The IRA distribution was included in income and you would deduct the charitable contribution as an itemized deduction. You would think that if the income and deduction were equal, that this would not lead to any tax liability. However, even if you contributed the entire distribution to charity, based on certain quirks in the tax code, this method may have resulted in a tax liability.
First, the IRA distribution would be included in your income and increase your adjusted gross income (AGI). The increased AGI may have reduced your itemized deductions and increased the amount of your taxable Social Security benefits. Also, if you did not itemize (i.e. you used the standard deduction) you would not receive any tax benefit for your charitable donation or, if you did itemize, the charitable donation may have been limited based on the AGI limitations. Any increase in income and/or reduced deductions would increase your taxable income and may have even pushed you into a higher tax bracket — causing an additional tax liability. Finally, in addition to that tax liability, the increase to your taxable income may increase your income-based Medicare premiums and prescription drug charges.
Now the playing field has changed.
Last year Congress permanently extended the ability for you to make charitable contributions from your IRA. If you are age 70 ½ or older, you can make a direct QCD from your IRA to a qualified charitable organization without owing any income tax on the distribution. The QCD is not included in income and you do not deduct the distribution as a charitable contribution. This avoids the potential tax and nontax consequences by essentially offsetting the income and deduction and not including either on your tax return. You may make up to $100,000 of QCD annually.
Also, you can use a QCD to satisfy your required minimum distributions (RMDs). In the year you reach age 70½, you must begin taking annual RMDs from your traditional IRAs using IRS tables based on your life expectancy. If you don’t comply, you can owe a penalty equal to 50% of the amount you should have withdrawn but didn’t. (An RMD deferral is allowed for the initial year, but you’ll have to take two RMDs the next year.)
So if you don’t need the RMD for your living expenses, QCD can be a great way to comply with the RMD requirement without triggering the tax liability that would occur if the RMD were paid out to you.
Finally, if you have IRAs with nondeductible contributions and earnings, the IRS has a special rule that allows you to treat the QCD as coming out of earnings. This allows you to donate the earnings without tax consequences and distribute the nondeductible contributions tax free to yourself. Without this rule, a proportionate share of each distribution is treated as earnings and nondeductible contributions based on the respective ratio in all of your IRAs. This could result in the portion of the distribution coming from earnings being taxable to you.
If you have questions about QCD or other giving strategies, contact me at HZemel@berdonllp.com or your Berdon advisor. We can help you create a giving plan that will meet your charitable goals and maximize your tax savings.
Hal Zemel, a Tax Principal at Berdon LLP, New York Accountants, has more than 20 years in public accounting and advises businesses in the real estate, service, and manufacturing sectors.