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January 1, 2013 update: Passage of the American Taxpayer Relief Act of 2012 has extended the QCD through the end of 2013. See this article for more details.
At the end of December, 2011, the provision for Qualified Charitable Distributions (QCD) expired. That provision allowed the taxpayer age 70½ or older to make direct distributions from an IRA account to a qualified charity, bypassing recognition of the distribution as income. For more information on the expired provision, see the original article about charitable distributions from your IRA.
With the expiration of this provision, you can still make charitable contributions of money distributed from your IRA. The difference is that these contributions are no different from a contribution that you’ve made from your savings account or regular income. In order to achieve a tax advantage from the contribution, you will itemize the charitable contribution on your tax return. Of course, in addition to this, if the money is from your IRA you’ll also have to recognize the distribution as income.
Let’s look at both ways to fully understand what’s different now.
The old way
Under the expired provision if you qualified, you could make a direct distribution from your IRA account to the qualified charity of your choice. Then when you were ready to file your tax return for the year, you wouldn’t include the amount of the direct distribution to the charity as income. This could also include your Required Minimum Distribution (RMD) for the year, as well.
By doing this, you didn’t have to recognize this income at all – which doesn’t seem so important until you see how it works in the new way.
The new way
Now that the QCD provision has expired, you can still make charitable contributions from your IRA, but it’s not as advantageous as the old way. Under this method (which can be enacted by anyone over age 59½ without penalty) you take a distribution from the IRA, and then send it to the charity of your choice.
(In actuality, the distribution doesn’t have to be from an IRA, but we’re doing a compare and contrast against the expired QCD arrangement, so that’s what we’ll use for the examples.)
When you get around to filing your tax return for the year now, you’ll have to recognize the distribution from your IRA as income. Later on the return, you can include the charitable contribution as an itemized deduction, eventually lowering your taxable income by the same amount. However, since you have to include the distribution as income, this will increase your overall income (unless you have Net Operating Losses from your business to offset the income), and will therefore also increase your Adjusted Gross Income (the bottom line of your Form 1040). The significance to this is that many tax provisions depend upon the Adjusted Gross Income (AGI) figure.
An example is deductible medical expenses – these are only deductible to the extent that they are in excess of 7.5% of your AGI. Miscellaneous Itemized expenses are subject to a similar “floor”: they must be greater than 2% of your AGI in order to be deductible. In addition, certain phase-outs are impacted by AGI level as well.
So you can see that increasing your income can have a significant impact on your overall tax return. Here’s a quick example of how this could impact a taxpayer.
Example
Taxpayer is single, age 73, and is subject to RMDs from his IRA. He wishes to make a charitable contribution of $10,000 from his IRA funds to his church. If this were 2011, he could make his distribution directly from the IRA to the church. Here’s how his tax return worked out:
| Income (pension and IRA) |
$50,000 |
| Adjusted Gross Income |
$50,000 |
| Medical Expenses |
$10,000 |
| Deductible Medical Expenses (above 7.5% of AGI) |
$6,250 |
| Charitable Contributions (beyond the direct QCD) |
$1,000 |
| Exemption |
$3,700 |
| Taxable Income |
$39,050 |
| Tax |
$5,888 |
Under the 2012 method, Taxpayer takes the distribution from his IRA and then sends it to his church. Here’s how the tax return works out now:
| Income (pension and IRA, plus his $10,000 additional distribution) |
$60,000 |
| Adjusted Gross Income |
$60,000 |
| Medical Expenses |
$10,000 |
| Deductible Medical Expenses (above 7.5% of AGI) |
$5,500 |
| Charitable Contributions (includes the additional $10,000 distribution) |
$11,000 |
| Exemption |
$3,800 |
| Taxable Income |
$39,700 |
| Tax |
$5,955 |
Under the new method in our example, the tax cost was increased by $67. This doesn’t seem like a lot, but if the circumstances were a bit different this could become sizeable – and who likes to pay extra taxes of any amount?
Bear in mind that this provision has expired and subsequently been extended in the past, so it’s possible that it could be extended again at some point in the future. Stay tuned.
