How Qualified Charitable Distributions Work

Trey Gevers CFP® |

Qualified Charitable Distributions (QCDs) are a tax-efficient way for individuals who are 70½ or older to donate to charity directly from their Individual Retirement Accounts (IRAs). Here's how they work and when they can be beneficial:

How Qualified Charitable Distributions Work:

  1. Eligibility:
    • The IRA account holder must be at least 70½ years old at the time of the distribution.
    • QCDs can only be made from traditional IRAs; they are not allowed from employer-sponsored retirement plans like 401(k)s or 403(b)s, though rollovers from these plans into an IRA may allow for a QCD.
  2. Donation Limit:
    • The maximum amount that can be donated as a QCD is $100,000 per year. If you file a joint return, your spouse can also make a QCD from their own IRA, allowing for a potential combined total of $200,000.
  3. Direct Transfer to Charity:
    • The distribution must be made directly from the IRA custodian to a qualified 501(c)(3) charity. This means the funds cannot pass through your hands or a regular checking account.
    • Donor-advised funds, private foundations, and supporting organizations do not qualify.
  4. Tax Benefits:
    • The amount donated via a QCD is excluded from your taxable income, which can be particularly advantageous if you don’t itemize deductions.
    • QCDs can satisfy all or part of your required minimum distribution (RMD) for the year, reducing the taxable portion of your RMD.
  5. Impact on Adjusted Gross Income (AGI):
    • By excluding the QCD from your income, you can potentially reduce your AGI, which can have various tax-related benefits, such as reducing Medicare premiums and qualifying for certain tax credits.

When to Use Qualified Charitable Distributions:

  1. RMD Management:
    • If you are subject to RMDs and do not need the extra income, using a QCD can prevent an increase in taxable income and the associated tax consequences.
  2. Standard Deduction vs. Itemized Deductions:
    • If you take the standard deduction and cannot benefit from itemizing charitable contributions, a QCD allows you to gain a tax benefit from charitable giving without needing to itemize.
  3. Reducing AGI:
    • Lowering your AGI can help with tax credits, deductions, and phase-outs that are based on income levels, as well as avoiding or minimizing taxes on Social Security benefits and higher Medicare premiums.
  4. Charitable Inclinations:
    • If you are charitably inclined and have significant assets in an IRA, a QCD allows you to support causes you care about in a tax-efficient manner.
  5. Estate Planning:
    • If you are concerned about the potential tax burden on your heirs, using QCDs during your lifetime can reduce the size of your taxable estate and the IRA balance that might otherwise be subject to income taxes when inherited.

Considerations:

  • Coordination with Other Income Sources: It's important to coordinate QCDs with other income sources to maximize the tax benefits.
  • Documentation: Ensure proper documentation and reporting on your tax return. The IRS does not provide a special form for QCDs, so it's up to the taxpayer to ensure that the QCD is reported correctly. (This is very important, as we’ve found cases where CPAs have omitted QCDs resulting in 0 tax benefit)
  • Consultation: Work closely with a tax advisor to ensure the QCD strategy aligns with your overall financial and charitable goals.

QCDs can be a powerful tool in both charitable giving and retirement income planning, offering unique tax advantages while supporting the causes you care about.