Table of Contents:
What is a Qualified Charitable Distribution?
Qualified charitable distributions (QCDs) were first introduced as a temporary provision by Congress in 2006 to give charitably minded individuals with a required minimum distribution (RMD) the ability to donate all or part of their RMD. QCDs were made a permanent part of the tax law in the PATH Act at the end of 2015. For years 2018-2025 QCDs are likely to have an even greater tax benefit as the standard deduction effectively doubled under the Tax Cuts and Jobs Act.
A qualified charitable distribution (QCD) allows individuals over the age of 70.5 to donate their required minimum distribution (RMD) straight to charity instead of picking up the RMD in taxable income and subsequently taking a charitable deduction. You might ask “it sounds like six of one, half a dozen of the other” and on the surface you are correct, but due to the way the charitable deduction is calculated on the tax return it can make a meaningful difference.
Your Charitable Tax Deduction Explained
There is a great deal of misunderstanding on how your charitable tax deduction works. Charitable contributions are considered itemized deductions. Itemized deductions for years 2019-2025 are the sum of your state and local taxes (capped at $10,000), interest expense, medical expenses over 10% of your AGI, and charitable contributions. The IRS allows you to take the LARGER of your total itemized deductions or the standard deduction. The 2019 standard deduction for those that are single is $12,200 and those married filing joint is $24,400. If you are over age 65 or blind there is an additional increase of $1,650 for single filers and $1,300 per spouse over 65 or blind for married filers.
Itemized vs. Standard Deduction
|Itemized Deductions||OR||2019 Standard Deduction|
|Medical (over 10% AGI) +||$12,200 Single / $24,400 Married Filing Joint|
|State & Local Taxes ($10k cap) +|
|Interest Expense +|
What is often overlooked is if your total itemized deductions in the left column above do not exceed your standard deduction in the right column then it does not matter how much you give to charity from a tax perspective. There is no tax benefit for your charitable contributions whatsoever if the standard deduction is higher your itemized deductions.
Jill and Bill want to make sure they receive a tax benefit from their charitable contributions. They have zero medical expenses, $10,000 of state & local taxes, $7,000 or mortgage interest, and $7,000 of charitable contributions for 2019. Jill and Bill total their itemized deductions to $24,000 and realize the standard deduction of $24,400 is higher. In order words Jill and Bill could have donated zero to charity and they would still receive the $24,400 deduction. There was no tax benefit to their $7,000 of donations.
Who is Eligible for a Qualified Charitable Distribution?
QCD are very powerful and can create meaningful tax savings but also have very strict requirements and boundaries that must be considered.
1) IRAs Only
QCDs can be taken from any type of IRA other than a SEP IRA or a SIMPLE IRA. This is important for two reasons. If you are still employed and your retirement savings is still in a 401(k) you cannot make a QCD until you roll your 401(k) over to an IRA. Also, IRA stands for individual retirement account which means all the rules related to QCDs are rules that apply per individual, not a married couple.
2) No “Young-ins” Allowed
You must be at least 70½ to make a QCD. The 70½ age requirement is literal, a QCD cannot be made even the day before you turn 70½. This rule is true even for inherited IRAs. If you inherit an IRA from your 90-year-old father who passed away last year you yourself must be 70½ to make a QCD, your father’s age when he passed away is no longer relevant for QCD purposes.
3) $100,000 Max
QCDs (in aggregate) can only exclude up to $100,000 from gross income each year. Remember from #1 above, all rules apply to the individual, so a married couple can exclude up to $200,000 if each spouse has their own IRA and qualifies separately.
4) Do Not Touch
The distribution must be made directly from the IRA trustee/custodian to a public charitable organization. The IRA owner cannot make a distribution and then write a check to the charity. Likewise, QCDs cannot be made to donor advised funds or private foundations.
5) No Benefits, Please
There cannot be any benefit received in exchange for the contribution. This is the most common issue taxpayers run into. It is common for charities to provide something in exchange for a donation such as tickets to a gala or a branded coffee mug but if any goods or services are received in exchange for the gift, then the entire QCD is invalid.
The Primary Benefits of Qualified Charitable Distributions
1) Tax Benefits
Dave and Susan have saved well and have a $100,000 RMD and $75,000 of qualified dividends for 2019. They also pay $10,000 in property taxes, $7,000 in mortgage interest, and wish to donate $10,000 annually. Dave and Susan do what seems natural and take their $100,000 RMD and write a $10,000 check to their favorite charity. Dave and Susan’s 2019 total income tax bill comes to $18,760.
If Dave and Susan were aware of the option to donate $10,000 of their RMD the story would be the same, but the result would be meaningfully different. Dave and Susan would take $90,000 of their RMD and direct the IRA custodian to make a $10,000 QCD to their charity of choice. Everything is the same except Dave and Susan did not touch the $10,000 donation, it went straight to the public charity. This minor tweak results in a $2,700 reduction in their total 2019 income tax bill reducing it to $16,060.
2) Potential Medicare Premium Reduction
The benefits of a QCD are not limited to income tax savings. The IRS uses adjusted gross income (AGI) to determine the level of wealth and income of an individual. One important AGI calculation for those over 65 is the Income Related Monthly Adjustment Amount (IRMAA) of their Medicare Part B premiums. Part B premiums start at $135.50 per month and scale up as AGI increases. Medicare Part B premiums are calculated using your AGI from 2 years ago. So, in reality the 2019 Medicare premium is calculated using 2017 AGI but for simplicity, below we are assuming the 2019 Medicare premium is calculated based on 2019 AGI.
Dave and Susan’s AGI originally was $175,000 ($100,000 RMD and $75,000 of qualified dividends.) For married couples with AGI between $170,000 and $214,000 the Medicare Part B monthly premium is $189.60. Dave and Susan’s annual Medicare Part B cost is $2,275.20.
However, if Dave and Susan use a QCD for $10,000 of their RMD, AGI is reduced by $10,000 to $165,000 ($90,000 RMD and $75,000 of qualified dividends). This $10,000 reduction of AGI lowers their Part B Medicare premium to $135.50 a month, saving them $649.20 in 2019 Medicare costs. As mentioned above, the real Medicare savings for lowering 2019 AGI would be on the 2021 premiums but the savings are just as real.
Talk to Your CPA
It is extremely important to note that the reporting of a QCD on Form 1099-R is no different than a regular distribution and your CPA will never know a QCD was made unless you inform him or her. The fact that a QCD was made means nothing unless it is reported as such on the tax return so be sure to communicate with your CPA so the tax savings are realized. Qualified charitable distributions can make a meaningful difference in household after-tax income. For Dave and Susan, the annual increase in after-tax take-home income is $3,350, but each and every situation is different so be sure to talk with your tax advisor about your specific situation.