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Tax-Efficient Charitable Giving from your IRA

charitable givingYou may have noticed with the new tax law that was passed for 2018, there was a significant change to the standard deduction. At first glance, even the topic of standard deductions seems very tax-tech-y, and something that many folks don’t pay attention to at all. But hidden in the details is something that may be of interest: a better, more tax-efficient way of charitable giving, using your IRA.

Granted, this is not going to apply to everyone. There are some restrictive rules in place. Specifically, you must have an IRA, and you must be at least 70½ years old, subject to Required Minimum Distributions (RMDs). And, you must be in a position where you are inclined to make charitable contributions. You may have made such contributions in the past, but probably not in the manner I’m talking about. Chances are, you probably made out a check to your chosen charity, and then when you did your income taxes you itemized the amount for deduction from your income. This is usually done with a form called Schedule A, which is attached to your standard Form 1040 tax return.

Everything worked just fine in the past with that process. However, some of you may have noticed that, over time, you may have switched from itemizing your deductions (with Schedule A) to using the standard deduction. This occurs when the standard deduction is larger than the total of your itemized (Schedule A) deductions.

I suspect this will be more common starting with your 2018 tax return, because the standard deduction has increased significantly. In 2017, the standard deduction for a married couple filing jointly was $12,700. And if they were both over age 65, the standard deduction was increased to $15,200. For many folks, that’s a lot of charitable contributions! Of course, charitable contributions are only a part of what makes up Schedule A itemized deductions – you’d include your real estate taxes, state and local income tax, sales tax, and medical expenses above a certain amount.

So, with those items added together with your charitable contributions, it’s quite possible for many taxpayers to breach the standard deduction amount and qualify to itemize.

But for 2018, the standard deduction for the same married couple, over age 65, will be $26,600 – an increase of more than $11,000 over the 2017 amount. (There are many other changes to the tax laws including the elimination of personal exemptions that makes this increase less valuable, but that’s a topic for another time.) Because of the new amount, along with some limitations that have been put in place on certain itemized deductions, many if not most taxpayers will be using the standard deduction for the first time in 2018.

With this in mind – you might wonder about whether it’s worthwhile to make those charitable contributions any more… after all, if you can’t itemize, those contributions won’t help your tax situation out, so why bother? (Many charities are looking at this as well and are quite concerned!) Hopefully, you were planning your usual support of the charity, just not getting the tax benefit from it like you have in the past.

But what if there was a way to be tax-efficient with your charitable giving? If you meet the restrictions I mentioned above (at least 70½ years old, and subject to RMDs from your IRA), you have exclusive access to a very tax-efficient way of charitable giving from your IRA. It’s called a Qualified Charitable Distribution (QCD), and it’s been around for quite a while – but I suspect it will become more popular with the changes in the tax law.

Charitable Giving from Your IRA

Below is a partly-fictitious interaction that I had with my father. You need to know that he’s far better looking in real life than I can make him look with my writing, for example. We had a similar discussion but I’ve fleshed this out much more and included purely made up figures to simplify the example.

Me: So, have you noticed the changes to the standard deduction from the new tax law? Probably won’t have to itemize your deductions this time around…

Dad: Yeah, we’ll still make the same charitable contributions we have in the past – but losing that deduction along with all the other changes will be hard to swallow. (See, I couldn’t make him look as dignified in writing as he really is. Try to cope with it.)

Me: Well, did you know there’s another way you can make those contributions, and still get benefit on your tax return? It’s called a Qualified Charitable Distribution (QCD).

Dad: I’ve heard of that, but never bothered to look into it. Seems like a lot of paperwork to do pretty much the same thing as we’ve always done.

Me: Au contraire! (We hardly ever speak in french, that was only for dramatic purposes.)

I’ll show you how it works:

Your income is $65,000* before any deductions. In the past, your itemized deductions came up to $20,000, and your personal exemptions were $8,100 so your taxable income was $36,900. Your itemized deductions included $10,000 that you send to various charities through the year, and the rest is real estate tax and medical expenses. Your annual RMD from your IRA is $5,000. (*All of these figures are completely made up, nice round figures to help with the example.)

In 2018, since your itemized deductions are less than the standard deduction, you’d just use the standard deduction. So your $65,000 income minus $26,600 equals $38,400 (remember there are no personal exemptions in 2018). That’s a higher taxable income than you had in 2017, because of the changes to the law. The lowered tax brackets would mean a lower overall tax bill, but you’re paying tax on a higher amount of income – and you didn’t change anything!

Now, if you used a QCD for your RMD of $5,000, your taxes would look a bit different. The QCD amount is not included in your income, so the income figure is reduced off the start to $60,000. Then then new standard deduction of $26,600 is subtracted, for a taxable income of $33,400. That’s $3,500 less than last year, and you didn’t have to itemize. How about that?

Dad: Well, that’s pretty amazing. So I only have to use this QCD and I can reduce my taxable income by $5,000?

Me: It gets better. Since you make a total of $10,000 in charitable contributions every year, you could use the QCD to distribute that full $10,000 to your chosen charities, and reduce your taxable income by that full amount.

If you send the full $10,000 to your chosen charities using QCD, your overall taxable income would be reduced even further, down to $28,400. That works out to a $1,200 reduction in taxes!

Dad: Well – I bet it’s really a hassle to do these QCDs. I don’t like hassles. (True statement. He doesn’t like hassles.)

Me: Not at all. You already have to notify your IRA custodian annually to have your RMD withdrawn. All you need to do is tell them to send the specified amounts to your chosen charities as Qualified Charitable Distributions. Then they take care of the rest of it. You’ll need to make sure you keep record of the QCD so that you can properly prepare your taxes – currently the 1099R forms don’t reflect whether your distribution was a QCD – so this is really important!

And so it went (fictitiously).

So if you fit into the parameters outlined above, you too could use this method to have more tax-efficient charitable giving. If you need more details, just reach out to me.

Astute reader BB pointed out that you must actually be 70½ years old to use the QCD. This could represent a challenge in timing if your 70½ age occurs very late in the year. BB also pointed out a problem with the earlier version of this article in that currently, Form 1099R does not have a provision or code to indicate that the distribution (or part of it) was a QCD. You’ll need to maintain your own records and make this notation in your tax return. 

2 Comments

  1. Scott says:

    Excellent post Jim. Below are a few additional bits of info for your readers, on the topic of QCDs:

    You are not allowed to do a QCD to some charities, e.g., donor-advised funds, private foundations, and supporting organizations.
    The IRA donor must not receive anything of value in return for the QCD donation. No tickets, dinners, etc. The “Full Deduction Rule” applies. You must receive an acknowledgement letter stating nothing of value was received.
    Since no value can be received by the donor, the QCD cannot go to a charitable remainder trust, a charitable gift annuity or a pooled investment fund.
    You are not limited to the RMD amount. The maximum dollar amount allowed per taxpayer, from the aggregate of their IRAs, is $100,000 year.
    Don’t leave a QCD till the end of the year! Charity should cash the check by the end of the year, as tax law is unsettled on whether date of postmark is the date of donation for a QCD.
    IRS deems the first money withdrawn from an IRA satisfies RMD requirements. IRA RMDs are irrevocable, so order matters. Therefore, for a QCD to count towards an RMD, do it first.
    The entire amount of the QCD is deemed to come first from the taxable portion of a mixed IRA. Since you choose the IRA from which a QCD is drawn, you may be able to draw down a mixed IRA more quickly.
    A QCD is excluded from income, so using a QCD to cover an RMD, can help avoid Medicare premium increases.
    There are times where a QCD is not the best choice. If you have highly appreciated LT cap gains assets, are still able to itemize, as a result of yearly deductible items or through bunching of several years worth of donations, the combination of avoiding cap gains tax and the income tax write-off may be better than the QCD. Micheal Kitces has an excellent article on this topic.
    Another good charitable IRA move is to consider charities as an IRA beneficiary. Depending on the tax rates of your heirs, if you have a charitable intent, it may be better for them to inherit step-up basis assets vs. tax deferred assets. This approach can be a sort or lower cost CRT, as you pull RMDs yearly for income and the charity gets what is left over, upon your death.

    I hope this additional information is useful!

    1. jblankenship says:

      Great points, thanks Scott!

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