In my opinion, QCDs are one of the most underutilized tax strategies around today. This is especially true with the new tax law. Those who qualify and are already giving to charity often get significant tax savings with little-to-no downside by utilizing them. In this article, I will go through some basics of QCDs and three ways they can save a taxpayer's money.
What is a Qualified Charitable Distributions (QCD)?
The year you turn 70 ½ you must take a Required Minimum Distribution (RMD) from your Traditional IRA accounts.. Distributions from these accounts are typically taxable unless your RMD is done as a Qualified Charitable Distribution. QCDs are a non-taxable direct transfer out of a Traditional IRA by someone 70 ½ or older of up to $100,000/year to a qualified charity.
One of the common questions I get about QCDs is, "How is giving my required distribution (or part of my RMD) as a direct transfer through QCD different than receiving my Required Distribution and then giving it to a charity?" It is different for multiple reasons. One of the main differences has to do with the location and the way each is recorded on your tax return. To make a long story short, the amount of a traditional IRA distribution received directly and later given to a charity increases your Combined, Adjusted, and Modified Adjusted Gross income. Qualified Charitable Distributions do not increase these* because they avoid your tax return altogether. I will elaborate on this, and a few other differences, as I go through the three ways QCDs can save you money.
#1 - You don’t itemize deductions OR if your charitable contributions are what cause you to itemize - Tax savings from charitable contributions are realized when you itemize deductions. If your itemized deductions (i.e., charitable contributions, property tax, state and local tax, mortgage interest, etc.) don't exceed your standard deduction amount, you do not receive tax saving for your charitable contributions. Many taxpayers over 70 ½ years old take the standard deduction rather than itemize. This is especially true now that the new tax law increased standard deductions to $12,000 per person. Those who qualify for QCDs and give to charity need to give QCDs a hard look. A QCD allows these taxpayers to transfer funds from their Traditional IRA directly to their favorite qualified charity, satisfy their required distribution and not increase their tax liability. It is a no brainer if they were going to give to that charity anyway.
Let's look at an example: Don and Barb have a combined RMD of $20,000 this year. They have $5,000 in itemized deductions + they give $10,000/year to their church. In 2018, their standard deduction is $24,000 which is $9,000 more than their itemized deductions. They would not receive a tax benefit for their charitable contributions. If, on the other hand, they gave $10,000 to their church via a QCD, they would only be required to take $10,000 more in distributions to satisfy their RMD, and they could still take the standard deduction of $24,000. All in all, they would reduce their taxable income by approximately $10,000.
#2 - Taxes on your Social Security Benefits – A QCD could help you reduce the taxes you pay on your Social Security benefits or keep you from having to pay taxes on your Social Security benefits altogether. Whether you are taxed on your Social Security benefits or not is based on your "Combined Income." Combined income is your adjusted gross income + Nontaxable interest + ½ of your Social Security benefits. If your combined income is below $25,000 for single filers or $32,000 for joint filers, you pay no federal income tax on Social Security benefits. As discussed above, receiving a distribution directly from your traditional IRA then giving it to charity would increase your combined income and could cause your Social Security benefits to be taxed or taxed more. The amount of your distribution done as a QCD would not increase your combined income.
#3 - On your Medicare, Part B Premiums - The amount you pay for your Medicare Part B premiums is based on your modified adjusted gross income (MAGI) two years ago. The higher your MAGI, the higher your premium will be. At the lowest income threshold ($85,000 single filer or $175,000 joint), premiums are $134/month and at the highest ($214,000 single filer or $428,000 joint), they are $428.60/month. Like #1, receiving a distribution from a Traditional IRA then giving it to a charity increases your MAGI but the amount of the distribution done as a QCD does not. For more information on income and Medicare premiums check out: https://www.medicare.gov/your-medicare-costs/costs-at-a-glance/costs-at-glance.html#collapse-4809
This article is not a comprehensive list of the benefits of QCDs but hopefully, you got some good information out of it. In summary, if you qualify for a Qualified Charitable Distribution (QCD) and you are tithing or giving to a charity anyway, why not take advantage of the QCD? With that said, everybody's situation is different and I would encourage you to work with a qualified tax advisor. If you are not taking advantage of QCDs and think it may make sense for you, ask your tax advisor about it.
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*The amount of a QCD is not considered taxable income on your tax return. The QCD amount shows up in line 15a of the 2016 form 1040 but is not included as a taxable distribution in line 15b. When you receive an IRA distribution directly and give it to a charity the distribution is added to your tax return on line 15a of the 1040 as a taxable distribution and then taken off farther down as a charitable contribution. In summary, what this means is that distributions done as a QCD are not considered when calculating your Adjusted or Modified Adjusted Gross income.
This article is written by Brandon Carter.