Advisor Perspective
Advisor Perspective
How to Reduce your Taxes by Using a Qualified Charitable Distribution
Are you getting the tax deduction you deserve for your charitable giving? If you are over 70 1/2, there may be a better way to give.
The Tax Cuts and Jobs Act of 2017 made several significant changes to the individual income tax, including doubling the standard deduction. As a result, an estimated 90% of American households now use the standard deduction instead of itemizing deductions when filing taxes each year. Because of this, those who use the standard deduction can miss claiming a deduction for donations made to qualified charities, and they may not even know it!
One strategy that offers significant tax benefits for certain taxpayers is using a Qualified Charitable Distribution(QCD). A QCD is a direct transfer of funds from your IRA, payable to a qualified charity. The benefits can be substantial, including reduced taxes, lower Medicare Premiums, and less taxation of Social Security. But implementing QCDs properly can be complex if you don’t know the rules.
Can You Make A QCD?
Consider using a QCD if you meet the following eligibility requirements:
- You must be 70 1/2 or older to be eligible to make a QCD.
- Several types of IRAs are eligible for QCDs: traditional, rollover, inherited, SEP (inactive plans only), and SIMPLE (inactive plans only). Employer retirement plans are not eligible for QCDs.
What are the other QCD rules?
- QCD funds must be given to public charities (501(c)(3) organizations). Gifts to private foundations and donor-advised funds are not eligible for QCDs.
- Payment must go directly from the custodian to the charity. If the IRA is set-up for check writing privileges, the checks must be written directly to the charity and must be cashed by the charity in the current tax year.
- The maximum allowable amount is $100,000 annually. This applies to the sum of QCDs made to one or more charities in a calendar year. If you file taxes jointly, your spouse can also make QCDs within the same tax year for up to an additional $100,000.
- There are no federal or state tax withholdings on the charitable amount.
Tax Benefits
Since a QCD is a distribution from an IRA, it counts towards satisfying the Required Minimum Distribution (RMD) amount set by the Internal Revenue Service. Since the QCD is not taxable, it directly reduces the taxable income for taxpayers. This in turn, reduces income taxes. The reduction in taxable income can also decrease the amount of Social Security that is subject to tax and potentially lower your Medicare premiums.
Tax Reporting
Be sure you report the QCD properly on your income tax return.
The IRA custodian will issue a Form 1099-R that will show the total amount of distributions from the IRA during the year. It will not distinguish between QCDs and other distributions. Here’s what you need to do:
- Report the full amount of the gross distributions on line 4a of your Form 1040.
- Subtract the QCDs and report the amount of the taxable distributions on line 4b.
- Next to line 4b, you should enter “QCD” to let the IRS know you excluded part of the distributions as QCDs.
What Can Go Wrong?
In order for the QCD to count towards the current year, checks written to the charity need to be deposited and clear the charity’s bank. If you are counting on the QCD to satisfy a portion of your RMD and it doesn’t clear before December 31st, you would incur a steep penalty for failing to fully complete your RMD. Consequently, we suggest leaving plenty of time for checks to clear at year-end.
Another possible issue relates to the order of distributions from the IRA and the need for planning ahead. Suppose your RMD for the year is $25,000 and you want to give $25,000 to charity in the same year. If you make at least $25,000 of QCDs, then you have satisfied both your RMD and your $25,000 charitable giving for the year. The money is out of your traditional IRA, plus there is no gross income reported on your tax return for the RMD. If instead you were to distribute $25,000 from your IRA to yourself in January and then decide later in the year that you want to give $25,000 to charity, it would be too late to get the full benefit of eliminating the income from your RMD. You can still give $25,000 to charity through the IRA, but it would not have the same impact.
The Bottom Line
If you own an IRA and meet the QCD eligibility rules, you can use the QCD rule to efficiently disperse money to a charity of your choice and receive the full tax benefit of your generosity. Keep in mind, implementing the distributions effectively and reporting them properly can be complex.
For further information or assistance with implementation, please reach out to your JMG financial advisor. The contents of this article may or may not be directly applicable to your situation. In either case, we invite you to pass this along to someone who may find it helpful.
Important Disclosure
Please remember that past performance may not be indicative of future results. Different types of investments involve varying degrees of risk, and there can be no assurance that the future performance of any specific investment, investment strategy, or product (including the investments and/or investment strategies recommended or undertaken by JMG Financial Group Ltd. (“JMG”), or any non-investment related content, made reference to directly or indirectly in this writing will be profitable, equal any corresponding indicated historical performance level(s), be suitable for your portfolio or individual situation, or prove successful. Due to various factors, including changing market conditions and/or applicable laws, the content may no longer be reflective of current opinions or positions. Moreover, you should not assume that any discussion or information contained in this writing serves as the receipt of, or as a substitute for, personalized investment advice from JMG. To the extent that a reader has any questions regarding the applicability of any specific issue discussed above to his/her individual situation, he/she is encouraged to consult with the professional advisor of his/her choosing. JMG is neither a law firm, nor a certified public accounting firm, and no portion of the content provided in this writing should be construed as legal or accounting advice. A copy of JMG’s current written disclosure Brochure discussing our advisory services and fees is available upon request. If you are a JMG client, please remember to contact JMG, in writing, if there are any changes in your personal/financial situation or investment objectives for the purpose of reviewing/evaluating/revising our previous recommendations and/or services, or if you would like to impose, add, or to modify any reasonable restrictions to our investment advisory services. JMG shall continue to rely on the accuracy of information that you have provided.
To the extent provided in this writing, historical performance results for investment indices and/or categories have been provided for general comparison purposes only, and generally do not reflect the deduction of transaction and/or custodial charges, the deduction of an investment management fee, nor the impact of taxes, the incurrence of which would have the effect of decreasing historical performance results. It should not be assumed that your account holdings correspond directly to any comparative indices. Indices are not available for direct investment.