Lowering Taxes with QCDs
You may have heard that that IRS requires individuals over of 70 ½ to begin taking distributions on their tax-deferred retirement accounts, forcing them to pay taxes on a portion of their IRAs, 401(k)s, etc. during their lifetime. These distributions are referred to as Required Minimum Distributions, or RMDs.
The problem is that these additional distributions will likely cause you to pay more taxes and could even push you into a higher tax bracket. So, is it possible to prevent the additional tax? One way retirees can lower their taxes is to increase their itemized deductions on their tax return.
Prior to the Tax Cuts and Jobs Act of 2017, the standard deduction was $6,350 for an individual and $12,700 for a married couple filing jointly.1 For those that made notable charitable contributions, it was more common to surpass those standard deduction amounts, allowing those givers to itemize their deductions.
However, with the passing of the TCJA of 2017, the standard deduction amounts today ($12,000 for an individual and $24,000 for a married couple) make it much more difficult to itemized deductions that surpass these higher marks.2 This may cause those that are charitably inclined to lose the tax benefits of making those donations. But, with the use of Qualified Charitable Distribution (QCD), they may be able to capture the tax benefits back.
What is a QCD?
A QCD is a direct transfer of funds from an IRA custodian, payable to a qualified charity, as described in the QCD Provision in the Internal Revenue Code.3 But, why is this even a big deal? The beauty of a QCD is that it allows you to take the standard deduction, but still get credit for your charitable contributions, which would ultimate lower your taxable income, and lower your taxes.
What are the Rules?
Like any other favorable tax break out there, it comes with rules and restrictions that need to be followed. They are:
- You must be at least 70 ½ years old at the time you request a QCD3
- QCDs carry the same deadline as RMDs, which is generally December 31st of each year3
- Distributions must go directly from the custodian to a qualified charity, meaning that checks need to be made payable to the charity, not to you, the IRA owner3
- Distributions must come from an IRA and not from a 401k b(SEP and SIMPLE IRAs only allowed if they are not active and receiving employer contributions)4
- The maximum QCD allowable is $100,000 per year, per individual. Married couples may each make a QCD up to $100,000 from their IRAs3
- Certain charities are not approved for QCDs, so it’s important to work directly with your advisor and accountant to ensure the charity you have in mind is a qualified charity4
- The IRA owner cannot receive any benefit or “kickbacks” as a result of the distribution4
To better understand how a QCD may benefit you, let’s look at a couple example scenarios.
First, let’s say Mary has an RMD of $10,000 and averages about $6,000 per year in charitable contributions. Let’s also assume that Mary, even with her $6,000 in charitable contributions does not exceed $12,000 in itemized deductions, so she elects to take the standard deduction. If Mary takes the entire RMD as a normal distribution and then makes a $6,000 charitable contribution, she will be taxed on the entire RMD amount ($10,000) and will essentially not get any reduction in taxable income as a result of the charitable donation.
However, if Mary decides to take $4,000 as a normal distribution and $6,000 as a Qualified Charitable Distribution, and she still takes the standard deduction, she’ll able to reduce her income by the $6,000 QCD amount. Subsequently, she’ll only be taxed on the remaining RMD amount of $4,000. This will lower her taxable income and cause her to pay less in income tax for the year. If her effective tax rate is 15%, then that would be a savings of $900 for that year.
This strategy can also work for those that give large amounts to charity. For example, if Bob donates $50,000 to charity, he would clearly exceed the standard deduction amount of $12,000 based on his charitable donations alone. However, Bob also has the option to take the standard deduction, and then reduce his income by another $50,000 through the use of QCDS, reducing his income by a total of $62,000 for the year.
These are just simple examples of how a QCD could potentially benefit you based on your individual situation. It may be worth talking with your advisor and accountant to see if a QCD would be a potentially useful strategy for you.
QCDs are not new. The rules permitting a Qualified Charitable Donation (QCD) were initially created under Section 1201 of the Pension Protection Act of 2006.4 However, these rules were only effective for two years, and this popular provision began a pattern of going into effect, then lapsing, then going into effect again. It wasn’t until the PATH Act of 2015, that the QCD became a permanent part of the IRS tax code.4
One final key to remember is to be sure you carefully understand the rules regarding QCDs so that you’re able to take advantage of the tax benefits offered. Also, it’s always important to keep detailed records of all your giving history. You should be able to obtain that information from each charity you donate to.
1 Publication 501 (2017, Exemptions, Standard Deduction, and Filing Information. https://www.irs.gov/publications/p501#en_US_2017_publink1000289299
2 Steps to Get a Jump on Next Year’s Taxes. https://www.irs.gov/individuals/steps-to-take-now-to-get-a-jump-on-next-years-taxes
3 Donating to a charity using a qualified charitable distribution (QCD). https://www.fidelity.com/learning-center/personal-finance/retirement/qcds-the-basics
4 Rules And Requirements For Doing A Qualified Charitable Distribution (QCD) From An IRA. https://www.kitces.com/blog/qualified-charitable-distribution-qcd-from-ira-to-satisfy-rmd-rules-and-requirements/
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