Tax Advantages of Qualified Charitable Distributions (QCDs)

Article Highlights:

• Understanding QCDs
• How QCDs Work
• Tax Benefits of QCDs
• Not Just for High-Income Taxpayers
• The IRA Contribution Trap
• Strategic Considerations

Qualified Charitable Distributions (QCDs) are a powerful tax planning tool, especially for retirees who must withdraw Required Minimum Distributions (RMDs) from their Individual Retirement Accounts (IRAs).  By sending a portion or all of an RMD directly to a charity, taxpayers might possibly cut their taxable income significantly, resulting in various tax benefits.

Understanding QCDs

A QCD is a direct transfer of monies from an individual's IRA to a qualified charity.  These dividends can be applied against your annual RMD, up to an inflation-adjusted maximum amount.  QCDs were originally introduced as a temporary measure in 2006, but have now become a permanent part of the tax code.

How QCDs Work

To qualify as a QCD, a distribution must match the following criteria:

• Eligible Accounts: The funds must come from a traditional IRA and the account holder must be at least 70½ years old at the time of donation.  Distributions cannot be made from SEP or SIMPLE IRAs.  Only non-taxable distributions from Roth IRAs can be used to fund the QCD.
• Direct Transfer Requirement: Funds must be sent directly from the IRA custodian to the qualifying charity.
• Qualified Charitable Organization: The beneficiary must be a 501(c)(3) organization. The donor must get an appreciation letter from the organization, following the same paperwork criteria as claiming an itemized charitable deduction.  Generally, private foundations, donor-advised funds, and supporting organizations are not eligible.  However, the SECURE 2.0 Act allows for a one-time $50,000 payout to specific charitable structures, such as charitable gift annuities, charitable remainder unitrusts, and charitable remainder annuity trusts.  The maximum lifetime distribution amount of $50,000 is adjusted for inflation and will be $54,000 in 2025.

Tax Benefits of QCDs

1. Income Reduction: Because a QCD is not taxable, it does not raise the Adjusted Gross Income (AGI).  This trait can be useful in more ways than merely avoiding income taxes on the RMD.

2. Increasing Income-Limited Tax Benefits: Lower AGI may result in increased eligibility for additional income-based tax advantages and credits.  Here are some instances.

• Social Security Taxation: By not boosting your AGI, QCDs can help keep lower-taxed Social Security benefits.
• Medicare Premiums: AGI determines the Medicare Part B and Part D premiums.  Keeping this figure low through QCDs allows you to avoid paying higher Medicare premiums.
• Itemized Deductions Threshold: Lowering your AGI can help you meet itemized deduction thresholds, boosting their value.

3. The same benefits as charitable contributions, plus more: Normally, when a taxpayer makes a charitable donation and itemizes deductions, the amount reduced taxable income.  However, a QCD gives the same advantage as a charitable deduction without the need to itemize, while simultaneously lowering AGI.  This is advantageous for taxpayers who use the standard deduction.

Not Just for High-Income Taxpayers

There is a prevalent misperception that QCDs benefit only high-income taxpayers because of the considerable yearly cap, which will be $108,000 in 2025 due to inflation adjustments from the original $100,000 ceiling.  However, QCDs can be used by any eligible taxpayer who meets the age requirement to reduce their taxable income and improve their tax condition.  Even tiny donations can leverage the benefits of lower AGI targets.  For a married couple, the annual limit applies to both spouses who have an IRA.

The IRA Contribution Trap

While QCDs might be extremely advantageous, you should be cautious of the so-called "IRA Contribution Trap."  The IRS considers any deductible IRA contributions made after age 70½ as a reduction in the permissible QCD amount.  For example:

1. If you contribute $6,000 to your IRA after age 70½ and want to make a $10,000 QCD, only $4,000 will qualify for the exclusion.  This rule diminishes the projected tax benefit of the QCD.

Understanding this catch is critical for retirees who are still working and may continue to contribute to their IRAs while preparing QCDs.

Strategic Considerations

Taxpayers should think about the timing and structure of QCDs, especially in years when they may have other large income events.  Planning your QCDs in combination with other taxable events will help you maintain lower AGI levels, maximizing the overall financial benefits.

For example, if a taxpayer anticipates a significant capital gain or receives a large payment from another source, a timely QCD might balance the income rise, assisting with AGI management.

Conclusion

Qualified Charitable Distributions are more than just a tool for charitable giving; they are also an effective approach for controlling taxable income and retaining eligibility for other tax-related benefits.  Understanding how QCDs function allows taxpayers to strategically plan their charitable contributions while optimizing tax benefits.

In summary, QCDs provide numerous benefits, including income reduction, augmentation of other tax benefits, and a streamlined method of charitable giving.  Whether you make little donations or use the whole annual limit, including QCDs into your tax plan can have far-reaching benefits for both your finances and the organizations you choose to support.

If you are retired and intend to make a major contribution to your place of worship or another charitable organization, such as your faith community's construction fund, you should consider a Qualified Charitable Distribution (QCD).  Please call our office for individualized assistance in determining how a QCD will help your specific circumstance.