The IRS has carved out a way for individuals over 70.5 to make charitable donations up to a certain amount that are tax exempt. We define this as a Qualified Charitable Distribution (QCD). If you practice charitable giving and are over the age of 70.5, read on!
Making donations to charitable organizations – particularly at year-end – is an annual tradition for many Americans. Some consider it an essential part of the holiday season; to give back.
Although this behavior is generally beneficial, there is a downside. Many of us tend to donate automatically without considering alternative and more effective ways to facilitate our donations. We simply go through the usual year-end motions. As a result, some Americans are missing a key gifting strategy that can help their money go even further.
Tax-Exempt Donations with Qualified Charitable Distributions
We must first reiterate that only individuals over 70.5 years of age are eligible to use the QCD tool. Say you’re turning 70.5 in a given calendar year. You’ll need to wait until after your birthday before any of your donations will qualify. So, plan your gifts accordingly! A typical IRA withdrawal will count toward the individual’s taxable income for the year. The beauty of QCD’s on the other hand is that they are exempt from taxes altogether.
Consider, for example, 73-year-old Jim who donates $5,000 to his local homeless shelter every December. The organization runs a donor-backed gift-matching program every December. Jim typically writes a check from his bank account for the donation. Instead, by sending the money as a check distribution from his IRA payable directly to the homeless shelter, Jim made a 100% tax-free donation. This money would’ve otherwise been 100% taxable. You can see how using this strategy consecutively, can result in great tax savings for Jim. In addition, this strategy can potentially give him even additional flexibility to give more as a result.
This gifting strategy is even more important now that nearly 90% of Americans take the standard deduction on their taxes and therefore don’t receive any tax deduction for their giving.
How Does a Qualified Charitable Distribution Work?
Following the rules exactly is necessary for your donations to qualify as QCDs, as there are certain caveats to consider. So be sure to mind the fine print!
Only certain account types qualify
The IRS specifies that individuals can only process QCDs from the following account types: Traditional IRAs, inherited IRAs, inactive Simplified Employee Pension (SEP) plans, and inactive Savings Incentive Match Plan for Employees (SIMPLE) IRAs. (Inactive SEP and SIMPLE IRAs are accounts that no longer receive employer contributions.)
You must send the donation directly to a qualified organization.
In order for a given distribution to meet the definition of a QCD, the funds must be payable to a qualified charitable organization, as defined in the tax code. If the organization has not legally registered as such, it cannot count your donation as a QCD.
Moreover, you must make the account distribution payable directly to the organization. For example, sending funds from the investment account to your bank account, and then writing a check to the charity, will not qualify.
The limit for QCDs is $100,000 per person per year
Another wonderful thing about QCDs is that you are not limited to just one transaction. You can process as many separate donations as you like, thereby spreading the benefits of this tax planning tool to multiple organizations if you so choose. However, the IRS does cap QCDs at $100,000 per individual per year. Anything donated over that amount, even if split between separate investment accounts, will not be considered tax-exempt.
Record keeping is key
The regular rules for substantiating your charitable donations must still be followed. That includes maintaining an account statement or written communication from the charity showing the organization’s name, the date of the donation, and the amount.
For any donation over $250, however, the record-keeping requirement is heightened. At that point, you must retain written confirmation from the organization that also confirms whether any goods or services were provided in consideration of the contribution.
The check-writing option
Some IRA custodians offer check-writing as a tool for account owners to use and it is well worth the time to inquire about this, especially for charitably inclined individuals who enjoy spreading donations across multiple charities.
Instead of filling out a form or calling the account custodian every time you’d like to process a donation, you can use check-writing. Check-writing gives you the ability to literally write the check yourself. You’ll need to make sure you have enough money available in the cash portion of your account. This is necessary to cover the full value of the check before writing it. For those who track their accounts closely, this shouldn’t be a problem.
Tax reporting essentials
Come tax season, the 1099-R your account custodian issues will not distinguish between your QCDs and your other distributions. The burden therefore falls to you to make sure this gets reported properly on your taxes. However, there is a space provided on your return to indicate the taxable amount of your IRA distributions versus the total sum of all distributions.
QCDs & RMDs
The value of the QCD increases once an individual has turned 73 and is subject to Required Minimum Distributions (RMDs). The RMD is an IRS mandate requiring the owners of certain types of accounts – including IRAs – to withdraw a certain dollar amount per calendar year. For account owners who do not need to take the RMD as income, and who would be making charitable donations regardless, utilizing the QCD is a great way to hit two birds with one stone. They can both fulfill their RMD and reduce their tax bill by sending their donation sum directly from their investment account.
Summary
QCDs are an incredibly valuable tool for account owners over the age of 70.5, but they are unfortunately overlooked as a gifting strategy all too often. In many cases, this is simply due to a lack of information; either being unaware of the tool itself or being unsure of the various guidelines and caveats around it. However, with just a little effort and record-keeping, you can take advantage of the QCD rule to maximize your charitable efforts and reap the tax benefits it provides.
