In December 2015, Congress passed a law allowing you to give up to $100,000 to charity directly from your individual retirement account (IRA) when you are over 70 1/2 years old without counting the distribution as taxable income. This type of charitable gift is called a Qualified Charitable Distribution (QCD).
Normally, when you take money out of your IRA it is a taxable event. The withdrawal adds to your taxable income and inflates your adjusted gross income (AGI). Then, if you give the same amount to charity, the charitable gift reduces your taxable income by the amount of the gift but it does not reduce your AGI.
Meanwhile, because a QCD is not taxable income in the first place, it has no effect on your AGI. This is important because itemized deduction phase-outs, exemption phase-outs, Roth contribution eligibility, the net investment income Medicare surtax, Medicare premium costs, the taxability of Social Security income, and some credit phase-outs all factor off your AGI.
Furthermore, giving a QCD directly from your IRA can allow you to benefit from charitable giving even if you don’t normally itemize your deductions. Giving directly from your IRA allows you to ignore your QCD IRA distribution when calculating your taxable income and also take the standard deduction.
Normally, charitable giving can only be deducted if it is less than 50% of your AGI. Giving directly from your IRA allows you to effectively reduce your AGI even if the gift amount would otherwise be greater than 50% of your AGI.
Qualified Charitable Distributions count as IRA distributions and can be used to satisfy all or part of your required minimum distribution (RMD). This makes them particularly useful for senior citizens who are still working, have a large pension, or, in general, find themselves in a higher tax bracket.
To fully count as a QCD, there are three factors that must be satisfied.
1. A QCD must come from a Traditional IRA or an Inherited IRA where the beneficiary is over 70 1/2 . QCDs cannot be made from employer-sponsored retirement accounts, like a Simple IRA or SEP IRA. These accounts must be first rolled over into an IRA Rollover before they can qualify.
2. The distribution must transfer directly to a qualified charity. “Qualified charity” is an official IRS designation. The list of qualified charities includes all 501(c)(3) organizations. Sadly, the list explicitly does not include donor-advised funds, foundations, or other grant-making organizations.
3. You must receive a confirmation letter from the charity. The letter must include the statement that no goods or services were received in exchange for the gift. This is the same requirement as is normally placed on the charitable deduction.
There are a few groups of people who might benefit from QCDs.
Qualified charitable distributions are particularly beneficial to charitably-inclined families whose IRA distributions would push them into the 15% federal capital gains bracket. By making a QCD instead, they are able to exclude the charitable IRA distribution from taxable income and benefit from 0% federal capital gains tax instead.
QCDs are also beneficial for people with most of their net worth in Traditional IRAs, retirees who do not need all of their money, and the charitably-inclined who do not itemize.
That being said, most charitably-inclined investors can experience more tax savings by making donations from appreciated stock in their taxable accounts than by QCD donations. Such stock donations experience double tax savings. Not only does the gift count as a deduction, reducing taxable income, but also the donation avoids paying the state and federal capital gains tax you would have owed had you sold the stock.
According to the IRS FAQ, “To report a qualified charitable distribution on your Form 1040 tax return, you generally report the full amount of the charitable distribution on the line for IRA distributions. On the line for the taxable amount, enter zero if the full amount was a qualified charitable distribution. Enter ‘QCD’ next to this line.”
As with any complicated tax saving strategy, there is a chance that, even if you follow these instructions perfectly, you may receive a paper audit from the IRS asking you to justify your return. If you choose to make a QCD, we suggest saving as much documentation as possible.
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