It is time to plan your qualified charitable distributions (QCDs) from IRAs for 2022 if you haven’t already. Anyone who’s age 70½ or older, makes charitable contributions and has assets in a traditional IRA should use QCDs to make at least some of their charitable contributions.
With a QCD, you’re converting a taxable distribution into a tax- free distribution. That’s a smarter way to give than writing a check, even if the contribution by check is fully deductible. The QCD is the most tax-wise way to make charitable contributions, with the possible exception in some situations of donating highly appreciated investment assets.
Before the QCD was available (and even today if you aren’t at least 70½), to make a donation to charity using traditional IRA assets, you first had to take a distribution from the IRA. The distribution was included in gross income and taxed. Then, you wrote a check to charity. Even if the money is transferred directly from the IRA to charity, it is treated as a distribution to you. There might be a tax deduction for the contribution if you itemize expenses on Schedule A.
But to itemize, your total of Schedule A deductions must exceed the standard deduction. Today, after the 2017 tax law doubled the standard deduction, a minority of taxpayers itemize expenses on Schedule A. That means they receive no additional tax benefit from charitable contributions. It is a different story when you qualify for a QCD. The QCD was added to the tax code as a temporary tax break in 2006, and a 2015 law made it a permanent fixture.
A charitable contribution from a traditional IRA that qualifies as a QCD isn’t included in your gross income. The trade-off is that you don’t receive a charitable deduction for it either. If you’re taking required minimum distributions (RMDs) from the traditional IRA, the QCD counts toward the RMD for the year.
That means you can take all or part of the RMD without having to include it in gross income to the extent you make a QCD for the year. (Though you can have a QCD any time after age 70½, RMDs now don’t begin until age 72.) So, by making your charitable contributions as QCDs, the money is out of your traditional IRA without increasing your tax bill. The non-IRA money you might have donated to charity can pay other expenses.
You made your RMD for the year tax-free or, if you aren’t subject to RMDs yet, reduced future RMDs tax free. Another good strategy is to make a QCD in a year you’re planning to con- vert all or part of a traditional IRA to a Roth IRA and also have to take an RMD. The rule is that when you convert IRA assets, you first have to take any RMD for the year. If you take it as a regular distribution, it’s included in gross income.
Then, the converted amount also is included in gross income. The RMD effectively adds to the tax cost of the conversion because you have to take the RMD first. But when you take the RMD as a QCD, it isn’t included in gross income. The QCD effectively reduces the cost of the conversion, plus you benefit charity. To qualify as a QCD, a charitable contribution must be made directly from the traditional IRA to a charity. Most of the time, the IRA owner directs the IRA custodian to distribute the money directly to a charity or charities.
An IRA custodian also can give the owner a check made out to the charity, which the owner can deliver to the charity. Some custodians give IRA owners checkbooks. The owners can take IRA distributions by writing checks against the IRA.
When a check is made out to a charity, that also qualifies as a QCD. There’s a potential timing problem when writing a check as a QCD. The IRA custodian will report the check as a distribution in the year the check cleared. If you write a check in late December and it doesn’t clear until early January, the custodian could report it as a distribution made in January.
If the QCD was intended to be part of your RMD, you might have missed taking all or part of your RMD by Dec. 31 and be liable for penalties. A transaction doesn’t qualify as a QCD if you take a distribution from a traditional IRA and make a contribution to charity of the same amount. The money must go directly from the IRA to char- ity to qualify as a QCD. That’s why it’s important to make QCDs first and then later take any additional RMD amount as a distribution. The QCD can exceed your RMD for the year.
If your RMD is $10,000, and you want to give $20,000 to charity during the year, the entire $20,000 of contributions can be made from the IRA as QCDs. But only $10,000 will count as an RMD. The traditional IRA owner must be at least age 70½ on the date of the transfer from the IRA to the charity. Suppose you turn 70½ in September and had money transferred from the traditional IRA to a charity in March.
That’s not a QCD; it will be included in your gross income. You have to be at least 70½ on the date of the contribution for it to qualify as a QCD. There’s a $100,000 annual limit per tax- payer (not per IRA) on QCDs.
In a married couple, each spouse has a separate $100,000 limit, but you can’t share the lim- its or split the QCDs. If one spouse wants to make more than $100,000 of charitable donations for the year, he or she can’t use part of the other spouse’s $100,000 QCD limit.
If the couple wants to have $200,000 of QCDs, each must donate $100,000 from his or her IRAs. Even if your RMD for the year exceeds $100,000, you can’t have more than $100,000 of QCDs. Charitable contributions from a traditional IRA that exceed $100,000 in a year will be non-QCD taxable distributions as described earlier.
Unused portions of the $100,000 limit don’t carry forward to future years. The $100,000 is a use-it-or-lose-it limit. Only pre-tax money can be used to make a QCD. That means any nondeductible contributions (after-tax money) in a traditional IRA can’t be used to make QCDs. A special rule for QCDs is you can designate that only pre-tax money in the traditional IRA is used to make the QCD while after-tax money stays in the IRA. Also, only accumulated earnings in a Roth IRA can be used to make a QCD.
But you wouldn’t want to make a QCD from a Roth IRA, because the distributions would be tax-free. In general, QCDs can be made only from traditional IRAs. They can be made from simplified employee pensions (SEPs) and SIMPLE IRAs only when the plan hasn’t received an employer contribution in the plan year that ends with or during the calendar year in which the charitable contribution is to be made.
In other words, the SEP or SIMPLE IRA must be inactive. Other employer plans, including 401(k)s, don’t qualify for QCDs. Inherited IRAs can be used to make QCDs. You don’t receive the QCD benefits if the IRA owner receives any benefit from the donation. Even a small gift or reward from the charity makes the entire contribution ineligible for a QCD. Also, you have to follow the basic rules for proving charitable contributions.
You must have an acknowledgement in writing from the charity regarding the amount and date of the contribution. For large donations, additional proof might be required. Only donations to public charities qualify as QCDs.
You don’t receive QCD treatment for contributions to private foundations, donor-advised funds and other tax-exempt groups that don’t qualify as public charities. A contribution from an IRA to fund a charitable gift annuity also doesn’t receive QCD treatment.
The SECURE Act permits contribu- tions to traditional IRAs after age 70½. It also prohibits an individual from com- bining a QCD and deductible IRA con- tributions made after age 70½. Details of these rules are in our November 2020 issue, which is available in the Archive of back issues on the members’ section of the website.