How to Reduce Taxable Income in 2018 with a Qualified Charitable Distribution
The Tax Cuts & Jobs Act has nearly doubled the standard deduction and as a result, the vast majority of taxpayers will no longer benefit from itemized deductions.
For many, this is a welcomed change, as it simplifies filing and may even reduce your tax bill, as long as your itemized deductions are less than $12,000 (single) or $24,000 (married filing jointly). Seniors qualify for an additional deduction of $1,300 (single) or $2,600 (married filing jointly).
Even if you take the standard deduction, however, there are still ways retirees age 70½ or older may further reduce their tax liability, such as a qualified charitable distribution (QCD). Don’t wait until December to look into using a QCD - find out now how it may save you taxes.
What Is a Qualified Charitable Distribution (QCD)?
A QCD is a direct payment of required minimum distributions (RMD) from an IRA account to a qualified non-profit organization, thereby satisfying the RMD without adding the tax liability that comes with additional income.
QCDs have been around since 2006, but the big changes in how deductions work on federal tax returns means that QCDs are getting more attention and will be used more in the future as a tax-planning strategy
Case Study: Using a Qualified Charitable Distribution to Reduce Your Tax Liability
Meet William and Betty Smith, a retired couple age 72 who own a diversified group of investment accounts, including traditional IRA accounts. The Smiths were passionate about a certain non-profit organization and planned a $10,000 donation in 2018.
They faced a decision: should they make a QCD from an IRA account or make the donation from a bank account and itemize it as a deduction?
Without the charitable contribution, the couple would benefit from the new standard deduction of $26,600 for seniors who are married filing jointly. After taking that deduction, the Joneses’ adjusted gross income would likely be $87,401. At this level, they would pay $11,106.88 in income taxes.
If they made the $10,000 donation from a bank account, their itemized deductions would be $31,600 (and they would no longer take the standard deduction because their itemized deductions are $5,000 greater). In this scenario, their adjusted gross income would be $82,401. They would pay $10,006.88 in taxes. This is $1,100 less than they would have paid without giving to the charity or claiming the deduction.
However, if they made a QCD, offsetting the tax liability from $10,000 of their IRA RMD, their adjusted gross income would be only $77,401. This is because the $10,000 QCD is not counted as income: the couple never actually received it. It went directly from the IRA account to the qualified non-profit. In this scenario, they pay only $8,906.88 in income taxes.
The end result?
The non-profit that William and Betty care about still get their $10,000 donation, and the Joneses reduced their tax liability by an additional $1,100 by making a QCD rather than writing a check to the charity from their bank account. Their overall tax savings was $2,200.
Who Benefits from a QCD?
A QCD is available to retirees age 70.5 and older who have a traditional IRA account. It’s also available to those who own a SEP IRA or Simple IRA, as long as the employer did not make any contributions during the year the QCD was made. Since a Roth IRA is not taxable, it would not be the best vehicle for a charitable contribution and you can’t use a 401(k) or 403(b) account.
You can’t transfer the funds to a donor-advised fund or a private foundation. You need to keep track of which charities are getting the distributions and documentation from the charities that they received the funds.
Generally speaking, those who benefit most from making a QCD:
already donate to charity or qualified non-profit. Of course, the main reason for giving to charity is to benefit the charity. The QCD is a strategy that may provide the most tax relief for those who give, but it does not pay for itself.
do not need RMDs to sustain their lifestyle. If other sources of income are sufficient to fund your lifestyle, the RMD from an IRA account may unnecessarily increase your tax liability, move you into a higher tax bracket, or even disqualify you from means-tested benefits. If this is the case, the QCD can really pay off.
How to Make a QCD
It’s really important to know that an RMD is considered satisfied by the first distribution. If you take an RMD for yourself, there’s no way to roll it back into an IRA so that you can then use a QCD to satisfy the requirement without it being counted as income.
You have to do it right the first time – no mulligans.
Here are a few important steps:
The distribution check must be made out to the non-profit organization.
The check can be sent to you to give to the non-profit, but it cannot be deposited into your bank account first so that you can write a check to the organization.
On tax Form 1040, report the full amount of the charitable distribution on the line for IRA distributions; on the line for the taxable amount, enter zero if the full amount was a QCD – enter “QCD” next to this line.
File Form 8606 if you made a QCD from a traditional IRA in which you had basis and received a distribution during the same year, other than the QCD; or if the QCD was made from a Roth IRA.
Most important, discuss the strategy with your tax advisor or financial advisor prior to either implementing the QCD or even taking the RMD.