Since 2006, taxpayers age 70½ or older have been able to make tax-free “qualified charitable distributions” (QCDs) from their IRAs. This provision survived through the years thanks to periodic, short-term extensions until it was made permanent under the Protecting Americans from Tax Hikes (PATH) Act of December 2015. With QCDs here to stay, let’s take a look at the tax benefits individuals can reap by making these contributions.
What QCDs mean for RMDs
To understand the benefit of QCDs, it is essential to first understand another tax component of IRAs: required minimum distributions (RMDs). RMD is the minimum annual amount the IRS requires individuals age 70½ or older to withdraw from their traditional IRA (not Roth IRA) or employer-sponsored retirement plan, such as a 401(k).
RMD amounts are added to taxable income and failure to take an RMD by the end of the year can result in a tax penalty of up to 50 percent of the RMD amount.
QCDs meet RMDs at the intersection of tax savings because unlike RMDs, QCDs are excluded from gross income. Therefore, eligible taxpayers can direct up to $100,000 per year to a qualified charity and avoid income tax on that amount.
How QCDs work
As mentioned above, only taxpayers 70½ or older are allowed to make QCDs. Another requirement is that the distribution must be otherwise taxable. Taxpayers filling jointly are each permitted to make a QCD of up to $100,000, for a total exclusion of $200,000 from gross income.
The IRS prohibits QCDs from going to private foundations, donor-advised funds or supporting organizations (as described in IRC Section 509(a)(3)). Furthermore, a QCD cannot be made in exchange for a charitable gift annuity or to a charitable remainder trust.
Here are some more important points to keep in mind regarding QCDs:
- QCDs are only excluded from taxable income; they cannot also be taken as a charitable contribution deduction on an itemized federal income tax return.
- Distributions taken from an IRA (including RMDs) and then subsequently donated to charitable causes do not qualify as QCDs.
- For multiple IRAs, QCDs are aggregated for calculation purposes related to taxable and nontaxable portion of a distribution from any one IRA.
QCD tax benefits
Some may wonder what is the advantage of using a QCD instead of taking a charitable contribution deduction. The answer is that QCDs streamline the process and likely result in greater tax savings versus taking an RMD, donating those funds to charity and then writing it off as a charitable deduction. The impact of including the RMD in taxable income could be more than the tax deduction from the donation, due to IRS limits on charitable contribution deductions. For taxpayers who don’t itemize deductions on their tax returns, the exclusion from gross income for QCDs is a tax-effective way to make charitable contributions.
QCDs are a convenient, and now permanent, method to support a charitable cause, get a tax break and satisfy annual RMD requirements. Your RKL tax professional or RKL Wealth Management advisor can demonstrate the benefits of QCDs and assist you executing this tax strategy.
Contributed by Laurie M. Peer, CPA, CFP®, partner in RKL’s Tax Services Group. She also serves as Executive Vice President of RKL Wealth Management LLC, the registered investment advisory subsidiary of RKL LLP. With 25 years of experience in taxation and financial planning, Laurie focuses on helping her clients achieve financial and life goals through clearly defined and customized plans with ongoing monitoring.