Qualified Charitable Distributions: A Worthy Tax Planning Strategy | Lord Abbett
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Retirement Perspectives

Want to do good and potentially lower your taxes? Consider the benefits of a Qualified Charitable Distribution if you are 70½ or older.

Read time: 3 minutes

After being waived by the CARES Act in 2020, required minimum distributions (RMDs) have returned in 2021. For IRA owners who don’t need the income derived from RMDs for everyday expenses and want to reduce their taxable income, a Qualified Charitable Distribution (QCD) serves as a valuable tool.

What is a QCD and what are the advantages?

A QCD is a tax-free withdrawal from an IRA that is made directly to a qualifying charity. Congress first established QCDs as part of the Pension Protection Act of 2006 and made them permanent in 2015. You can transfer up to $100,000 annually to eligible charities tax-free.

  • Satisfies your RMD requirement: A significant advantage of QCDs for many IRA owners is that taking a QCD can satisfy your RMD for the year.
  • Excludes taxable income: By doing a QCD, those funds are not included in your taxable income for the year (up to $100,000). This is a huge benefit because an RMD is generally includable in taxable income. This could also prevent, reduce, or even eliminate the 3.8% surtax on investment income, Medicare Part B and D premium surcharges, Social Security benefit taxation, alternative minimum tax, loss of exemptions, deductions, credits and other means tested programs.
  • Deduction vs. itemization: Since the Tax Cut and Jobs Act many taxpayers are no longer eligible to receive a deduction for making charitable contributions because they take the standardized deduction versus itemizing. A QCD is attractive to those taxpayers who do not itemize because it allows them to receive a tax break for a charitable contribution. The benefits a QCD provides are in addition to the standardized deduction.

QCD requirements

  • You must be at least 70½ (your 70 ½ birthday) to make a QCD.
  • Funds must be transferred directly to a charity approved by the IRS. Qualifying charitable organizations include churches, educational organizations, hospitals and medical facilities, foundations, etc. See the IRS searchable database of approved charities here. Private foundations or donor advised funds do not qualify for QCD treatment.
  • Employer sponsored retirement plans, including a 401(k), 403(b) or 457(b) do not qualify for QCD treatment.
  • You may not receive anything of value from a charity (such as concert tickets, gifts, etc.) in exchange for making a QCD.
  • A QCD can only be done for the current year; for example, a QCD for 2021 must be completed by December 31 of this year. If you miss the deadline, you can’t do a QCD for 2021; there are no “prior year” QCDs.
  • QCDs must consist of only pre-tax IRA dollars. This begs the question “How do I qualify for QCD treatment if any of my IRAs contains basis” (after-tax dollars)? QCDs are an exception to the IRS IRA pro-rata distribution rule.  QCDs are distributed from IRA pre-tax money first!
  • Roth IRAs are generally not QCD eligible because qualified Roth IRA distributions are tax-free. Thus, QCDs can only be made from a Roth IRA only if the Roth IRA had not satisfied the requirements for a “qualified distribution.”

PRACTICE TIP – For individuals with IRA checkbook accounts: Writing a check to an eligible charitable organization before the end of the year will not meet QCD criteria. Instead, It (check) must be cashed and debited from the IRA before the end of the year.

Confusing QCDs with RMDs

Under the “First Dollars (out) Rule” funds distributed from an IRA in any year an individual is subject to an RMD satisfies that year’s RMD. Therefore, a retiree who previously took their RMD for a year cannot use a QCD later in the (same) year to satisfy their RMD. Why? Because RMDs are not eligible for rollover. If a retiree previously took their 2021 RMD, those funds cannot be recontributed (to the IRA) and subsequently have them redistributed as a QCD.

Notably, a distribution in excess of their 2021 RMDs is eligible for rollover to an IRA within 60 days followed by having the funds paid directly to charity as a QCD.

Retirees that want to reduce their income with QCDs should transfer the amount they want to give to charity directly from the IRA to the qualifying charity first, prior to taking any RMDs for the year.

Tax Reporting

An IRA provider is not required to report a QCD transaction on Form 1099-R; instead, it will be coded as a “normal” IRA distribution. In other words, Form 1099-R will not indicate the distribution as a QCD and therefore a non-taxable transaction. However, a normal distribution is generally subject to income taxes.

How does a taxpayer reconcile this apparent inconsistency? The IRA owner must advise their tax professional of the QCD. The charity should provide a receipt (or some other form of documentation substantiating the donation) of the donation from the IRA including the date and amount. If the QCD was not reported and the return was previously submitted, individuals can generally amend their return going back three years.

Key Takeaways

  • A QCD is a tax-free transfer from an IRA to a qualifying charity.
  • QCDs count towards your RMD for the year. If you must take RMDs but don’t really want or need the income, a QCD is a method of distributing otherwise taxable retirement (IRA) funds tax free, while supporting a cause you care about.
  • QCD treatment applies to traditional IRAs, and inactive SEP and SIMPLE IRAs.

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