How to Use an IRA Giving Strategy to Increase Tax Benefits
Submitted by Roy J. Wullich
C005 – Rochester Chapter
Many of us give to charities not only out of a sense of helping but also because it can be a great tax strategy. Typically, individuals give cash or securities directly to their charities of choice, which results in an itemized deduction reported on Schedule A of their personal tax returns. With tax law changes, specifically an increase in the standard deduction to $24,000 for a married couple filing jointly, in some cases, these types of itemized deductions have had their tax benefits lessened or even eliminated completely.
Using a Qualified Charitable Distribution Strategy
An alternative to the traditional methods of charitable giving for those who are 70 or older is a qualified charitable distribution, or QCD. A QCD is a distribution from an IRA made directly to a qualified charitable entity. The total allowable distribution is limited to $100,000 per year per taxpayer ($200,000 for a married couple if both have IRAs). This tax-saving strategy has been around for a while but was recently made a permanent part of the tax code. It’s important to note that a QCD can be used to satisfy the required minimum distribution from an IRA if an individual is over age 70.
QCDs Reduce the Donor’s Taxable Income
The tax treatment of a QCD differs from the traditional method of giving because a QCD is reported as an above-the-line deduction. Simply put, the amount of a gift directly from an IRA to a charitable organization can reduce the donor’s adjusted gross income (AGI). This treatment is important because a QCD may give greater tax benefits than giving cash or securities, which are reported as an itemized charitable deduction on Schedule A. For example, if a married couple has taxable income consisting of $20,000 from Social Security and $80,000 from a required minimum distribution from an IRA, their AGI is $97,000 after subtracting the portion of Social Security excluded from tax. They have modest expenses, so they give $20,000 to charity with no other income or deductions to consider here. As of the 2018 tax year, they would receive no positive tax effect from their charitable donation because the amount falls below the $24,000 standard deduction, which brings their taxable income to $73,000 ($97,000 of AGI minus the $24,000 standard deduction). Given their AGI, they would owe ~$8,379 in federal income tax. If instead they make the $20,000 donation using a QCD strategy, the taxable amount from their IRA distribution is reduced by $20,000 which in turn drops their AGI from $97,000 to $77,000. After the standard deduction of $24,000, their taxable income is $53,000 meaning they owe $5,979 in federal tax. The couple saves $2,400 in taxes with no negative impact on their cash flow as a result of making their charitable contribution via the QCD mechanism. This is a simplified example, but it shows how restructuring the charitable gift to meet QCD requirements can potentially reduce taxes that are owed.
It effectively increases disposable income to the couple without affecting the amount the charity receives. Note that this tax savings strategy may become even more powerful if the AGI reduction moves them into a lower tax bracket, reduces their state income taxes, or reduces their net investment taxes due. The higher their charitable donations, the greater potential for tax benefits which may magnify their total tax savings.
QCDs may lower Medicare premiums
Another potential positive effect of a QCD is that by reducing adjusted gross income, they may also reduce the donor’s Medicare costs. In 2018, differences in AGI (from two years ago) may reduce Part B monthly premiums as much as $294.60 and Part D costs can vary as much as $74.80 per month. For example, a married couple with a 2016 AGI of $270,000 will pay $348.30 per month per person for Medicare Part B in 2018 and pay another $54.20 in addition to their plan premium for Part D. If they made a $100,000 qualified charitable distribution in 2016 their AGI would have been lowered to $170,000. Their Part B cost would drop to $134.00. Part D cost would just be their plan premium. This represents a savings of $214.30 on Part B and $54.20 on Part D, per person per month.
That means the total annual cost for both of them is reduced by $6,444. While that savings may not be enough to justify giving away $100,000, the lesson here is to note that utilizing the QCD mechanism for charitable donations they’re already making may provide multiple benefits by lowering their overall taxable income.
Tips for implementing a QCD
The donor will need to take certain steps for a qualified charitable distribution and to report it when filing their tax return. First, a QCD must be paid directly to a qualifying charity. The distribution cannot come to the individual first, but instead must be distributed directly from their IRA account to the charity. The QCD must be made by Dec. 31 to count for the current tax year (just like a required minimum distribution). While on the surface this may sound complicated, in actuality, it’s no more complicated than sending cash or donating shares of stock to a charity. Many charitable organizations are well-prepared to accept donations via QCDs, especially now that the tax law has made the strategy more favorable.
Once the donor decides to utilize a QCD, it’s advisable to coordinate with the charity and the custodian of their IRA to ensure the correct steps are followed for the distribution to qualify by going directly from the donor’s IRA account to the organization. Another detail to manage is the reporting of the distribution on their federal tax return. This is important since the IRA custodian will report this IRA distribution as a normal taxable distribution on the 1099-R tax form for their account. Whether they prepare their own return or enlist a CPA, they will need to report the full IRA distribution on the 1040 line for IRA distributions. Then, they will enter $0 on the line for the taxable distribution amount (assuming the full distribution was a QCD).
Remember, under current tax law, the maximum QCD is $100,000 per year or $200,000 per couple if both individuals have IRAs. Projecting all the tax effects with and without a qualified charitable distribution is essential to deciding whether or not to implement this strategy. These examples show that qualified charitable distributions are important to consider for taxpayers who are interested in making charitable contributions, are looking to maximize tax efficiencies, or who don’t need all the cash provided from their required IRA withdrawals. Since this strategy has both financial planning and multiple tax implications, it is best used after fully evaluating all the options for meeting the donor’s charitable giving intentions in the context of their individual situation and consulting with their tax advisor.