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How You Can Maximize the Tax Benefit of Your Charitable Giving

How You Can Maximize the Tax Benefit of Your Charitable Giving

| February 16, 2022
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Here's how to donate to charities, get pre-tax money out of your IRA, and pay 0% tax while lowering future required minimum distributions.
We have a wonderful client, Joni, who is very charitably inclined. One of the most rewarding things we have done as a wealth management team is to help Joni establish a charitable remainder trust with the American Heart Association as the beneficiary. In addition to this trust, Joni supports several other non-profit endeavors, donating about $10,000 to $12,000 annually. A few years ago, Joni reached an important milestone: She turned 70 ½ (at the time the age to begin taking required minimum distributions). Knowing her age and of her annual donations, we called Joni to tell her of a planning opportunity that was now available to her.

Thanks to the Tax Cuts and Jobs Act’s higher standard deduction, fewer taxpayers are itemizing on their returns. This may have simplified tax preparation for many, but those who use the standard deduction now miss out on several popular tax breaks, including claiming a deduction for gifts they make to a charity.

Fortunately, there is a strategy that can keep those who give (at least those who are age 70½ or older) and the charities that receive their contributions on course with charitable donations. When we spoke with Joni, we explained her first required minimum distribution (RMD) would be over $40,000 dollars. “Great!” she said, “Send it to me and I will use some of that to donate to my charities.”

“You could do that, Joni,” we explained, “But you will be better served by doing a qualified charitable distribution (QCD).” We outlined to her the reasons why: Between the 2018 and 2025 tax years, a change in the tax law nearly doubling the standard deduction has made itemizing less advantageous for her. In the past, itemizing her charitable donations reduced her taxable income. Now, by utilizing the standard deduction, she gets no further tax benefit for her charitable gifts. Luckily for our charitably inclined client, due to her age and required distributions, there is an option for her to take both the standard deduction and lower her taxable income by her donations: utilizing a QCD.

We told her that taxpayers age 70½ and older can use a QCD to donate up to $100,000 annually directly from a traditional IRA to an eligible public charity, without counting that amount as taxable income. Instead, if applicable, it could count toward her required minimum distribution (Since 2020, after the passage of the SECURE Act, RMDs now begins at age 72) and reduce the taxable amount of her mandatory withdrawal.

We explained, “Using part of your RMD as a charitable donation will exclude that amount from your adjusted gross income (AGI) for the year, which means that, in addition to reducing your income taxes, it may also decrease the amount of Social Security that is subject to tax and potentially lower your Medicare premiums. Even if you are under the RMD age, (but at least 70½ years of age) a QCD is a way to donate to your charities, get pre-tax money out of your IRA, and pay 0% tax while lowering future required minimum distributions.”

“So”, Joni replied, “what you are saying is that if I take my RMD, put it in my checking account, and then write a check to my favorite charity, I will pay income tax on the full required distribution amount, and this extra taxable income may cause me to pay more each month in Medicare premiums?”

“However,” she continued, “If I instruct my IRA custodian to send a check from my IRA directly to the charity via a QCD, I won’t pay income tax on this amount of the distribution and by doing this I potentially avoid a higher Medicare surcharge?”

“Correct,” we said, “As long as certain rules are followed.”

Like most things IRA related, there are rules to adhere to:

  1. Must be age 70½. A QCD is only allowed if the distribution is made on or after the date you actually attain age 70 ½. It is not sufficient that you will turn 70 ½ later in the year.
  2. Beneficiaries can do QCDs. QCDs are not limited to IRA owners. An inherited IRA beneficiary may also do a QCD. All the same rules apply, including the requirement that the beneficiary must be age 70½ or older at the time the QCD is done.
  3. Eligible retirement accounts. You may take QCDs from your taxable IRA funds. QCDs are also permitted from SEP and SIMPLE IRAs that are not still contributory. QCDs are not available from an employer plan. 
  4. $100,000 annual limit. QCDs are capped at $100,000 per person, per year. 
  5. RMD can be satisfied. A QCD can satisfy (or partially satisfy) your required minimum distribution (RMD) for the year. A QCD can also exceed the RMD amount for the year up to the $100,000 annual limit. 
  6. Only taxable amounts. QCDs apply only to taxable amounts. No basis (nondeductible IRA contributions or after-tax rollover funds) can be transferred to a charity as a QCD. 
  7. Direct transfer is a must. If you want to do a QCD, you must make a direct IRA transfer from the IRA to the charity. If a check that is payable to a charity is sent to you for delivery to the charity, it will qualify as a direct payment. 
  8. Charitable contribution requirements. A QCD can only be made to a charity that is eligible to receive tax-deductible charitable contributions under IRS rules. 
  9. Charitable substantiation requirements apply. You should have documentation to substantiate the donation (something in writing from the charity showing the date and amount of the contribution). Important to note: To qualify as a QCD, there cannot be any benefit back to you from the funds that go from your IRA to the charity, such as paying dues required for membership or a fundraising dinner. 
  10. Reporting on the tax return (this one is IMPORTANT!). The IRA custodian will not be separately reporting the QCD. There is no code or box on the 1099-R to identify the QCD. It will be up to you to let the IRS know about the contribution by including certain information on your tax return.

If you are charitably inclined and are age 70½ or older, don’t miss out on this valuable tax break!