As a result of the Tax Cuts and Jobs Act, the vast majority of taxpayers began taking the increased Standard Deduction. Because of this, most taxpayers will no longer get a tax benefit from their charitable giving.
What do you do if you’ve always enjoyed the double thrill of giving to your favorite charity while reducing the amount of tax to Uncle Sam? One possible giving strategy is to complete a Qualified Charitable Distribution or “QCD” to the qualified charity of your choice directly from your IRA. A QCD allows you to take some or all of your Required Minimum Distribution (RMD) from your IRA and not have it counted as income. For example, if your RMD is $10,000 and you completed a QCD for $10,000, you’d report that you took $10,000 from your IRA, you’d write QCD next to box 4b, and you’d report that none of it was taxable. This transaction would also satisfy your RMD for the year. (See Diagram)
In addition to the benefits of essentially receiving a tax deduction, a second benefit relating to the taxation of Social Security can also exist. The way Social Security is taxed is based on a complex formula. However, one important thing to understand is, generally, the lower your Adjusted Gross Income (AGI), the less of your Social Security is considered taxable income, subject to certain limits. Let’s look at an example of how this might impact a retired client.
John and Jane Smith
The Smiths are both 71 years old. They have $54,000 a year of combined Social Security, $7,000 a year of dividends, and combined Required Minimum Distributions from their IRAs of $30,000 per year. They’re also charitable and typically give about $10,000 a year to their church. Before the changes in the tax code they had made their charitable gifts from cash on hand and claimed their gift as an itemized deduction on their return. Starting in 2018, they begin making the $10,000 gift as a Qualified Charitable Distribution from their IRA. Because the standard deduction has increased to $26,600 for married couples filing joint and over 65, if they had continued with the normal method of giving, they would not have received a tax benefit for their charitable donations. But if they made their gifts from the IRA, they would have been allowed to exclude their gift from their taxable withdrawals from the IRA. Let’s look at the impact of this below:
|No QCD||With QCD|
|Total Social Security||$54,000||$54,000|
|Taxable Social Security||$23,000||$14,500|
|Total IRA Distributions||$30,000||$30,000|
|Taxable IRA Distributions||$30,000||$20,000|
|Adjusted Gross Income||$60,000||$41,500|
|Medical Deductions Above 7.5% of AGI||$500||$1,887|
|Total Itemized Deductions||$14,500||$5,887|
|$1,300 x 2 People over age 65||$2,600||$2,600|
|Total Standard Deduction||$26,600||$26,600|
|Greater of Standard Deduction or Itemized||$26,600||$26,600|
This example illustrates that by making their charitable distribution from the IRA it reduced the amount of the taxable IRA distribution from $30,000 to $20,000. It also reduced the portion of their Social Security that was considered taxable from $23,000 down to $14,500. So by making the $10,000 gift from their IRA, it reduced their taxable income by $18,500. This resulted in roughly $2,000 in tax savings just by completing their gifting a little differently than they had the prior year.
To complete a QCD, you must be over the age of 70 ½ when the distribution occurs. Additionally, the money must be distributed from your IRA directly into the name of the charity. If you get the check and endorse it over to the charity, that doesn’t count. There is a cap on annual gifts of $100,000. Remember that the tax form for the distribution (Form 1099-R) won’t specifically say that the distribution went to a charity, so you’ll need to explain what occurred to your tax preparer. It’s very important to work with a qualified financial planner and tax preparer who know how to follow all the rules and can determine exactly how much this strategy could save you.