The IRS posted their final regulations regarding how charitable gifts to receive state tax credits will be handled for gifts made after August 27, 2018. The rules can be summarized into two new rules:
- You must reduce your federal itemized charitable deduction by the amount of tax credits you receive in return.
- You may count your charitable state tax credits towards your federal State and Local Tax (SALT) deduction.
Unfortunately, there are a few giving strategies that complicate this simple model. One of the most obvious confusions is a Qualified Charitable Distribution (QCD).
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 70½ years old without counting the distribution as taxable income. This type of charitable gift is called a Qualified Charitable Distribution (QCD).
You can use a QCD as your gift to acquire state tax credits from Virginia programs like the Neighborhood Assistance Program (NAP) and the Education Improvement Scholarships. Both of these programs offer a state tax credit for 65% of your total charitable contribution.
If you were taking an itemized deduction for this gift, by the new IRS regulations, only 35% of the value of the gift (the total gift minus the 65% credits you received) can be deducted on your federal itemized deductions.
Although you can elect to itemize your QCD, this is not normally the most advantageous. 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, the charitable gift reduces your taxable income by the deductible 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. It is left off of your return. In order to report a QCD, you are simply supposed to subtract from your total IRA distributions the amount your gave and write “QCD” in the margin.
So this all raises the question, does receiving state tax credits change the exempt-ability of your QCD from taxable income?
The answer, we find in the IRS code. Internal Revenue Code (IRC) section 408(d)(8) is the portion of the code which defines QCD rules. In subsection (C), we get the following text:
(C) Contributions must be otherwise deductible
For purposes of this paragraph, a distribution to an organization described in subparagraph (B)(i) shall be treated as a qualified charitable distribution only if a deduction for the entire distribution would be allowable under section 170 (determined without regard to subsection (b) thereof and this paragraph).
In other words, it is far worse than most people would imagine. If a portion of your charitable gift is nondeductible, then no portion of the gift can be counted as a Qualified Charitable Distribution.
That being said, you can still give directly from your IRA to receive state tax credits. You will just need to report the distribution as a taxable IRA distribution and then itemize to receive the deductible portion. However, if this is the way that you will have to file, then you would likely be better off giving appreciated stock from your taxable account.
Therefore, the simplest answer to “Can I still use a QCD to get State Tax Credits?” is: No. You should likely give appreciated stock instead. However, there is one odd exception.
According to the recent IRS final regulations, if the tax credits received are 15% or less than the amount transferred, then you can deduct the full amount of your gift on your Schedule A Itemized Deductions. This means your IRA distribution to charity can count as a QCD if you receive 15% or less of the gift in tax credits. This is because it counts as a QCD if it could have been otherwise entirely deductible and it is otherwise entirely deductible if the tax credits received are 15% or less than the amount transferred.
To complete a QCD where you also receive tax credits, you can give a QCD in the amount you want the charity to have, but then only apply for tax credits up to 15% of the value of that gift.
This loophole has no obvious downside. So if you are giving a QCD to a charity that offers tax credits in your state, you may as well apply for 15% or less in tax credits.
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