Normally, when you take money out of your IRA it is a taxable event. The IRA 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 (if you can itemize) but it does not reduce your AGI.
In contrast, a Qualified Charitable Distribution (QCD) is not counted as taxable income in the first place. Therefore, a QCD has no effect on your AGI or taxable income. Keeping your AGI low can have a significant tax savings. Roth contribution eligibility, the net investment income Medicare surtax, Medicare IRMAA premium costs, the taxability of Social Security income, and some credit phase-outs are all determined by your AGI.
When you choose to gift out of your IRA to a charity, there are some best practice guidelines that should be followed to ensure that you have met the criteria to have your gift count as a QCD. However, there is even more that must be done at tax time to ensure that your QCD is reported properly to the IRS, because, quite frankly, the IRS has no idea you did a QCD until you tell them.
IRS Form 1099-R is the form that tells the IRS what money came out of your IRA. For many people, the “Gross distribution” and “Taxable amount” are a hazy picture of what will actually be filed on their return as the “Taxable amount not determined” box is checked. That’s because literally any funds leaving your IRA — rollovers, consolidations, conversions, and distributions of any kind — are all reported on those two lines.
Qualified charitable distributions are withdrawals from your IRA, so they will be included in your 1099-R “Gross distribution.” Also, your custodian does not keep track of where the assets were transferred. For this reason, QCDs are also reported to the IRS on the “Taxable amount” line.
Imagine an individual who had a total required minimum distribution (RMD) for 2018 of $10,000. They decided to satisfy that distribution requirement by withdrawing $2,000 to their taxable account and gifting $8,000 to their charity of choice in a QCD.
This example person’s 1099-R will have a $10,000 gross distribution and a $10,000 taxable amount with the “Taxable amount not determined” box checked.
If they provided this 1099-R and their confirmation letter from the charity for the gift to their tax preparer, the preparer would report a $10,000 taxable IRA distribution and then attempt to itemize their deductions so that they could report an $8,000 charitable deduction. However, this could impoverish the individual as they would have lost out on the benefit of a lower AGI and the ability to get tax savings from charitable gifts while still taking the standard deduction.
As the IRS states in the Frequently Asked Questions, the correct way to report a QCD is very weird. They write:
How do I report a qualified charitable distribution on my income tax return?
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. See the Form 1040 instructions for additional information.
You must also file Form 8606, Nondeductible IRAs, if:
- you made the qualified charitable distribution from a traditional IRA in which you had basis and received a distribution from the IRA during the same year, other than the qualified charitable distribution; or
- the qualified charitable distribution was made from a Roth IRA.
In order to report a QCD, you are simply supposed to take it out of the taxable amount you finally put on your 1040 and write “QCD” in the margin.
There is no Qualified Charitable Distribution IRS form to fill out or line to put your QCD total. You simply subtract from taxable IRA distributions the amount of the QCD and write “QCD” in the margin.
For our example person, this would mean putting $10,000 in the “Total IRA Distribution” 1040 line and then putting $2,000 ($10,000 minus the $8,000 QCD) in the “Taxable IRA Distribution” line with “QCD” written in the margin.
If you use a tax preparer, you need to tell him or her that your gift was a QCD for this to be filed correctly.
If you take the standard deduction, this could be the difference between getting a tax benefit from your gift and not getting a benefit. If you are close to an AGI-based IRMAA Medicare Surcharge line, this could be worth thousands of dollars in your premiums owed.
Be sure to remember to tell your tax preparer that you did a QCD. Or if you do your own taxes, be sure to subtract the value of your QCD from the “Taxable IRA Distribution” line.