A case for the Qualified Charitable Distribution (QCD) from an IRA

 

After the passage of the 2017 tax cuts, the standard deduction for married couples filing jointly has doubled to $24,800 (tax year 2020). The tax plan also put a $10,000 deduction limit on the amount of State and Local Taxes (SALT), which includes property taxes.

For many couples, the combination of a higher standard deduction and lower income/property tax deductions, means that they are no longer itemizing their deductions — they are taking the higher standard deduction when they file their returns.

The 2017 tax cuts did reduce the administrative burden for those couples, as it is easier to prepare a return with no itemized deductions. The unintended consequence of these changes is that many couples (as well as some single taxpayers) are no longer seeing a tax benefit from their charitable contributions.

In the past, a couple might pay $25,000 to $50,000 or more in combined property taxes and state income taxes (especially in a high-tax state like New York). If they then donated $10,000 to various charities, their itemized deductions might be in the $35,000 to $60,000 range (not including medical expenses or other itemized deductions).

Under the current law, this same couple would only get to deduct $10,000 worth of property taxes and state income taxes, plus their $10,000 of charitable contributions, for a total of $20,000. In this scenario, this couple would be better off electing to take the standard deduction of $24,800, since it is greater than their $20,000 of capped itemized deductions.

Charities feared that an increase in the standard deduction might result in lower levels of charitable giving, and it appears their fear was justified. According to Giving USA 2019: The Annual Report on Philanthropy for the Year 2018, individual giving declined by 1.1% from 2017 to 2018 (a decline of 3.4% adjusted for inflation).

A 1.1% decline might not seem like much, but this data is for tax year 2018. My fear is that many taxpayers may not have realized the difference in their tax situations until after completing their 2018 tax returns — in the spring of 2019. We may end up seeing a greater decline in 2019 giving once those returns are filed in the spring of 2020. A 1.1% decline is small in percentage terms, but equates to approximately $3.25 billion in reduced charitable contributions. It’s a significant dollar amount.

My fear is that many taxpayers may not have realized the difference in their tax situations until after completing their 2018 tax returns — in the spring of 2019. We may end up seeing a greater decline in 2019 giving once those returns are filed in the spring of 2020.

There is a solution

I would hope that an individual would not be supporting a charitable cause only for the tax benefit of their gift, but the data suggests that was a driving factor for some givers.

For individuals or couples who must take a Required Minimum Distribution (RMD) from their IRAs, there may be a better way.

The ability to make a Qualified Charitable Distribution (QCD) from an IRA has been around for a while, but this planning strategy is becoming more appealing for certain taxpayers since more people are filing their taxes with the standard deduction and not itemizing.

The IRA rules allows anyone who is over the age of 70 ½ (or 72 based on the recently passed SECURE act — see Section 113) to direct up to $100,000 of their IRA balance to a qualified charity each year. The amount that is donated to charity also counts towards your Required Minimum Distribution.

By making your charitable donation directly from your IRA to a qualified charity, the distribution still counts towards your required distribution for the year, but the amount of the charitable donation will not be added to your income for tax purposes.

Let’s look at how the math affects this hypothetical couple:

Photo by Esther Ann on Unsplash

John and Sally Jones

· Age in 2020: 75

·Typical Charitable Donation(s): $10,000 annually

· Property/Income Taxes: $10,000 (capped)

· Other itemized deductions: $2,000

· In this example, they have $22,000 worth of itemized deductions, so they would take the standard deduction of $27,400 ($24,800 regular plus $2,600 since they are both over age 65)

· IRA(s) Balance: $1 million. Required Minimum Distribution: $43,700

They must distribute $43,700 from their IRA(s) sometime during the calendar year. Whether they need it to live on, or they direct their distribution to an after-tax investment account, it still needs to come out of the IRA.

Rather than distribute $43,700 from their IRAs, and then gift $10,000 of that cash to a charity, they would be better off taking a distribution of $33,700, and sending $10,000 directly from their IRAs to the charities.

In this example, they have still met the RMD requirement, because $43,700 was removed from their IRA, but they will only be taxed on $33,700, since the remaining $10,000 went directly to a charity.

When they file their taxes, they will still take the $27,400 standard deduction, but their taxable income will be $10,000 less due to the charitable contribution, providing a total benefit of $37,400.

How to properly execute a Qualified Charitable Distribution:

· The IRA owner must be over the age of 70 ½ (or 72 based on the SECURE act) on the date of the distribution. This is important. If you are turning 70 ½ in April, you can’t process the donation in March. You must wait until you have hit the appropriate age.

· The donation must be sent directly from the IRA custodian (such as Charles Schwab) and the check must be made payable directly to the charity.

· The donation can only be made to a public charity. The donation cannot be made to a Donor Advised Fund (such as the Schwab Charitable Fund) as a conduit.

· Ask the charity to send you a gift acknowledgment letter so you have proof of the gift for your tax records.

Helpful with Medicare Premiums

If you have a higher income, the law requires an adjustment to your monthly Medicare premiums.

Looking back to our example with John and Sally Jones. Let’s suppose their Modified Adjusted Gross Income (MAGI) is $175,000. At that level, their Medicare Part B premiums would be $189.60 per month, which includes a $54.10 surcharge because their income is over $170,000.

If they directed $10,000 of their RMD to a charity, their MAGI would be reduced from $175,000 to $165,000, for a monthly savings of $54.10 or approximately $650.

What about gifting appreciated stock?

I am a big fan of funding charitable donations with appreciated stock. For individuals or couples who are not yet required to take an RMD from their IRA, gifting appreciated stock makes the most sense. Even if you are not able to itemize your deductions, you can still remove the future capital gain from your portfolio by gifting appreciated stock.

If your charitable donations are high enough so you can still itemize your deductions, gifting appreciated securities will usually result in a higher tax benefit (assuming you are not paying a surcharge on your Medicare premiums).

To learn more about gifting appreciated stock, and using donor advised funds as a conduit for your gifts, you can read my article about these strategies here:

The decision to financially support a charity is deeply personal. Once you have made that decision, you should work with your advisors (financial, tax, and legal) to implement a plan that will accomplish your charitable goals in the most tax efficient manner.

About the author

William B. Burns, Jr. CFP® is a CERTIFIED FINANCIAL PLANNER professional and President of Burns Matteson Capital Management, a Financial Planning and Investment Advisory Firm with clients throughout the United States. He helps high-net-worth families reduce the worry and anxiety sometimes associated with wealth, allowing families to reclaim that time to reinvest back into their family, social, and professional relationships. www.BurnsMatteson.com