One of the most underutilized and often misreported charitable giving strategies is Qualified Charitable Distributions (QCD). Taxpayers 70.5 and older can use their IRA to gift directly to charity without creating a tax liability. In addition, if required to take annual Required Minimum Distributions (RMDs), the charitable gift will reduce the annual RMD. That sounds like a no-brainer, right?
Step 1: Initiating the QCD
To qualify as a QCD, the gift must be made directly from an IRA account. Employer plans, such as 401ks or 403bs, aren’t eligible for QCDs, just IRAs. However, there are a few ways to transfer the funds from your IRA to the charity of your choice.
Some custodians will send you a checkbook on the account. In that scenario, you write the check yourself, make it payable to the charity, and send it to them. If a checkbook isn’t an option, the custodian can issue a check on your behalf to the charity. To qualify as a QCD, the funds can never be deposited in your checking account. Moving the funds into your name first will disallow the QCD and result in taxes owed on the distribution.
If you are required to take annual RMDs and already give to charity, then QCDs are a great strategy. Frankly, there’s no reason not to utilize QCDs. For example, if your RMD is $50,000 and you intend to gift $10,000 to charity this year, you can gift the $10,000 directly from your IRA and transfer the remaining $40,000 out of your IRA. $50,000 was distributed from the IRA, but only $40,000 is taxable to you. The lower taxable amount means your modified adjusted gross income (MAGI) will be reduced. MAGI impacts other areas of your financial situation, such as Medicare premiums and taxation of Social Security. The lower your MAGI, the better!
Giving the charity plenty of time to deposit the check is important. For example, if you write a QCD check on December 30, the charity may cash the check in January of the following year. If that distribution was part of your RMD, you might face a penalty since the distribution wasn’t finalized in the intended tax year.
Step 2: Reporting the QCD
Initiating the QCDs is usually the easy part. However, reporting them correctly requires some communication with your tax preparer.
All distributions out of IRA accounts will generate a 1099-R tax form. This form is sent to the IRS and the account holder to document the total amount of distributions from the IRA, the taxes that were withheld, and the appropriate tax codes. The 1099-R does not break down the distributions any further than that.
Even if the custodian of the IRA issued the check directly to the charitable organization on your behalf, they don’t verify the organization is a charity.
Continuing with the example above, the 1099-R will reflect a $50,000 IRA distribution. It is up to you to tell your tax preparer that $10,000 of that distribution was a QCD. Nothing on the 1099-R indicates that your QCDs are part of your total distribution, so if you don’t tell them, they will report the total distribution as taxable income. You can double-check the reporting on your tax return by reviewing lines 4a and 4b.
Line 4a is the total amount of IRA distributions. Line 4b is the taxable amount. If you utilize QCDs, the amount on line 4b should be less than 4a.
Mistakes happen, and you may realize your QCDs weren’t reported correctly on your tax return. If so, you can file an amendment to correct the reporting and lower your tax liability for the year.
QCD Limitations
Taxpayers can donate up to $100,000 annually using QCDs. Gifts beyond that amount are allowed but are not tax-free. It’s also important to note that QCDs cannot be gifted to a donor-advised fund. As mentioned previously, employer plans do not allow QCDs. However, you can roll over the funds to your IRA if you are no longer employed. Then, once in the IRA, you can use the funds for QCDs.
Summary
QCDs are an efficient way of supporting charitable organizations you care about, but you want to ensure you follow the process through your tax filing. Communication with your tax preparer will keep everyone informed and ensure your QCDs are tax-free.
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The material has been gathered from sources believed to be reliable, however Bedel Financial Consulting, Inc. cannot guarantee the accuracy or completeness of such information, and certain information presented here may have been condensed or summarized from its original source. To determine which investments or planning strategies may be appropriate for you, consult your financial advisor or other industry professional prior to investing or implementing a planning strategy. This article is not intended to provide investment, tax or legal advice, and nothing contained in these materials should be taken as such. Investment Advisory services are offered through Bedel Financial Consulting, Inc. Advisory services are only offered where Bedel Financial Consulting, Inc. and its representatives are properly licensed or exempt from licensure. No advice may be rendered unless a client agreement is in place.
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