There’s Still Tax Magic from Making Charitable Contributions from Your IRA

The qualified charitable distribution (QCD) from an IRA is the best way for most people age 70½ and older to make charitable contributions.

The QCD was a temporary innovation in 2006 but was made a regular part of the tax law in 2015. You should include the QCD in your tax planning if you’re charitably inclined at all. When a charitable contribution that doesn’t qualify as a QCD is made from a traditional IRA, the contribution is treated as a distribution and included in the owner’s gross income.

The result is the same whether the contribution is made by a direct transfer from the IRA custodian to the charity or a distribution is made to the IRA owner who then makes a charitable contribution.

The owner can take a charitable contribution deduction but only as part of itemized expenses on Schedule A. Most people don’t itemize expenses anymore because the standard deduction is so high. There was an exception in 2020, when up to $300 of charitable contributions could be deducted without itemizing expenses.

There’s also an exception in 2021. A married couple can deduct up to $600 of charitable contributions without itemizing and an individual can deduct up to $300. But the results are very different when the contribution qualifies as a QCD.

When a QCD is made, the charitable contribution made from the IRA isn’t included in the gross income of the IRA owner. The owner also doesn’t take a deduction for the contribution.In addition, the QCD counts toward any required minimum distribution (RMD) for the year.

The beginning age for RMDs now is 72, but QCDs still can begin at 70½. RMDs increase gross income and can, by themselves, increase income taxes and the Stealth Taxes, such as taxes on Social Security benefits and the Medicare premium surtax.

Suppose your RMD for the year is $17,000. Make at least $17,000 of QCDs and you’ve satisfied both your RMD and $17,000 of your charitable giving for the year. The money is out of your traditional IRA, but there is no gross income on your tax return.

A QCD can be a good strategy during a year when a traditional IRA is being converted to a Roth IRA.

In the year of the conversion, you still are required to take your RMD for the year, regardless of when during the year the conversion is done. You won’t be able to convert the RMD amount. Without the QCD, you’d have to include the RMD in gross in-come along with the converted amount. The alternative is to make a QCD with the RMD amount.

That keeps the RMD amount out of your gross income.

Here’s how to ensure a charitable distribution from an IRA qualifies as a QCD.The charitable contribution must be made directly from the IRA custodian or trustee to the charity. If you receive a distribution from the IRA and later contribute to charity, that doesn’t count as a QCD. That distribution will be included in gross income.

As an alternative, the IRA custodian can give you a check that is payable to the charity, and you can deliver that check to the charity. That will count as a QCD.

You must be at least age 70½ by the date of the charitable contribution. If you turn 70½ during the calendar year, transfers made from the IRA to a charity before you turn 70½ don’t count as QCDs.

Plus, QCDs are limited to no more than $100,000 annually per taxpayer. No matter the amount of your RMD for the year, you can give up to $100,000 to charities from your IRA as QCDs.

If your charitable giving from the IRA for the year exceeds $100,000, the contributions above $100,000 are treated as non-QCDs and taxed as described earlier in this article.

When your QCDs are less than $100,000, you don’t carry over the unused amount to increase the limit in future years. The $100,000 annu-al limit is a use-it-or-lose-it amount.The $100,000 annual limit is per tax-payer. There is no sharing of the limit be-tween married taxpayers.

For a married couple to have $200,000 of QCDs for the year, each spouse must have IRAs worth at least $100,000 and give $100,000 from his or her IRAs. If only one spouse has IRAs, he or she has only the $100,000 QCD limit and the other spouse’s QCD limit can’t be used.

A QCD can be made only from an IRA. Employer retirement plans aren’t eligible for QCDs. Also, QCDs can be made from simplified employee pen-sions (SEPs) and Simple IRAs only when the plan hasn’t received an employer contribution for the plan year that ends with or during the calendar year in which the IRA owner plans to make the charitable contribution from the IRA.

Roth IRAs technically are eligible for QCDs, but not as a practical matter. That’s because after-tax money can’t be used to make a QCD. All contributions to a Roth IRA are after-tax money; only investment earnings are pre-tax money. Also, there is no benefit to making a QCD from a Roth IRA because the distribution is likely to be tax-free anyway.

Likewise, after-tax contributions in a traditional IRA can’t be used to make a QCD. Only pre-tax money in the traditional IRA qualifies for a QCD. Unlike in other situations, the pre-tax money in the traditional IRA can be segregated and designated for a QCD.

In other situations, taking money out of the traditional IRA would be automatically pro-rated between pre-tax and after-tax money.

When your IRA has a mix of pre-tax and after-tax money and you use the pre-tax money to make a QCD, that reduces the pre-tax money in the IRA. That also reduces income taxes in future years when the IRA money is distributed or converted to a Roth IRA.

The IRA owner can’t receive any benefit from the charitable contribution. Any small gift or reward from the charity could make the entire contribution ineligible for QCD treatment. A QCD, however, can be used to satisfy a pledge the IRA owner made to the charity.All the regular rules for substantiating charitable contributions must be followed.

That means the IRA owner should have documentation in writing from the charity acknowledging the amount and date of the contribution.QCDs can be made only to public charities that are eligible for charitable contribution deductions under the regular IRS rules. Gifts to private foundations and donor-advised funds or gifts that are used to fund charitable gift annuities are not eligible for QCDs.

The SECURE Act permits contributions to traditional IRAs after age 70½. It also prohibits an individual from combining a QCD and deductible IRA contributions 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.Be sure you report the QCD properly on your income tax return.

The IRA custodian will issue a Form 1099-R that will show the total amount of distributions from the IRA during the year. It won’t distinguish between QCDs and other distributions. You’ll report the full amount of the gross distributions on line 4a of your Form 1040. Subtract the QCDs and report the amount of the taxable distributions on line 4b.

Next to line 4b, you should enter “QCD” to let the IRS know you excluded part of the distributions as QCDs.