An Introduction to Qualified Charitable Distributions
“It’s tax deductible” is a frequently cited incentive for making a donation to a nonprofit organization. Yet even though the majority of Americans now take the standard deduction when they file their federal taxes—and therefore typically can’t take a tax deduction for a charitable contribution—they continue to give generously. In 2019, individual charitable contributions hit an all-time high of $309.6 billion, nearly a 5% increase over the prior year.[i]
If you no longer itemize, there is a charitable giving approach that allows you to reap the tax benefits of donating to an organization that meets IRS criteria for deduction eligibility: a qualified charitable distribution (QCD).
A contribution is considered to be a QCD when the money the nonprofit organization receives comes directly from your IRA, rather than from you. And while this contribution isn’t tax deductible, it still packs a punch because the distribution doesn’t count as taxable income. Eligible individuals can contribute up to $100,000 per year by making a QCD. Your eligibility is determined by your age—70 ½ or older—rather than how you file your federal tax returns.
The QCD/RMD relationship
QCDs were first introduced in 2006. Originally a temporary measure, QCDs officially became part of the tax code in 2015.
Perhaps the best-known benefit of making a QCD is that it can be used to offset the dreaded required minimum distribution (RMD). Until recently, individuals were required to start taking an annual RMD in the year that they turned 70 ½, the same age at which they become eligible to make a QCD. The SECURE Act of 2019 ended the QCD/RMD synchronization by raising the age at which the RMD mandatory withdrawal requirement applies to 72.
The RMD offset isn’t the only tax advantage of channeling your charitable donations from your IRA rather than your checking account. Because the IRS doesn’t consider a QCD to be taxable income, making a qualified donation will reduce your adjusted gross income (AGI) for the year. This can help you avoid paying higher premiums for Medicare Part B and Part D, which are based on your AGI. A lower AGI also means you could pay federal tax on a smaller percentage of your Social Security benefits.
Those who begin making QCDs before the RMD mandate hits gain an additional benefit: Because the QCD reduces your IRA balance, it will lower those future RMD payouts because they are partially based on year-end account value. For example, if you had an IRA with a $500,000 account balance and you made a QCD that resulted in a year-end account balance of $400,000 the year you turned 72, the RMD calculation would be based on that lower dollar amount. However, if you had made the same dollar amount contribution outside of your IRA, you would be looking at a higher RMD due to a potentially larger IRA account balance.
How you give makes a difference
For those who itemize on their federal tax returns, there are a number of differences between making a QCD and a tax-deductible contribution. These include:
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QCD eligibility is linked to your age, while the tax benefits of a charitable donation aren’t restricted by age.
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The contribution must be made via a direct transfer from the IRA custodian versus cash or payment from your personal account. For that reason, donations of noncash items, such as a car or piece of art, are ineligible for QCD status.
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Donations for which you received a benefit, such as an event dinner or performance, aren’t QCD eligible.
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A QCD lowers your AGI while a charitable contribution reduces the amount of taxes you owe. (This point is crucial if you receive Social Security benefits and are paying Medicare premiums, because AGI is a consideration for both benefit programs.)
Of course, there is always an exception.
For tax year 2021, there is a slight modification to the tax treatment of charitable contributions for those who don’t itemize. You are allowed to claim up to $300 in charitable donations ($600 for married couples filing jointly) as a deduction, which will lower your 2021 AGI. Of course, that amount pales compared to the QCD limit of $100,000 ($200,000 for married couples filing jointly who each have an IRA).
Implementing a QCD strategy
If you are using a QCD to offset your RMD, there are some guidelines for making the most of this strategy.
A good approach is to direct your IRA distributions early in the year to the organizations that you wish to donate to. Otherwise, you may have completed your annual charitable giving prior to fulfilling your RMD. That puts you in the position of having to take taxable distributions from your IRA that you may not want or need.
Because funds from any account other than an IRA are ineligible, a QCD generally works best with a planned charitable contribution. It is important to tell your tax professional which IRA distributions qualify for QCD status, because the 1099R you receive from the account’s custodian won’t indicate that. Your tax professional can also help you understand your state’s QCD tax treatment, which can vary from federal tax treatment.
To learn more about QCDs and discuss when they make sense as part of your charitable giving and tax-advantaged IRA distribution strategy, please speak with your BDO wealth advisor.
[i] Giving USA 2020: The Annual Report on Philanthropy, June 16, 2020, accessed March 12, 2022.
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