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Using the QCD Rules to Save Extra Money on Charitable Donations if You Are at Least Age 70 1/2
by Steve T. Kohman, CPA, CSEP, CSRP
Most people who are over age 70½ will have a traditional IRA and many will make some donations to charity. If this describes you, you should be glad to know that the Qualified Charitable Distribution (QCD) rules are now permanent tax laws. In prior years, the QCDs were not approved as tax law until the tax year was almost over, so making use of them was often difficult. But as it has become part of the permanent tax law, we can now safely plan to put them to use.
At age 70½, you will have to take Required Minimum Distributions (RMDs) from your traditional IRAs for the year in which you turn 70½ and beyond. Using the QCDs for your donations means saving extra money is possible for many, if not most, people age 70½ or older with IRAs.
QCD Rules and Limitations
Under the QCD rules, you can make charitable donations directly from your IRA rather than the normal procedure of taking a taxable distribution and then taking an itemized deduction for the donation. When using QCDs, you are not able to claim that contribution as a charitable donation on your itemized deductions. People often think this will not make any difference in your taxes and, although in some cases it might not if you itemize deductions, in many cases it creates significant savings. Since the standard deduction is so much higher starting in 2018, it is more likely that people will not itemize deductions anyway, so it provides a great way to save on taxes.
The QCD rules require you to be age 70½. They cannot be used now if you don’t turn 70½ until later in the year. You will have to wait until you are 70½ before donating to charity directly from your IRA using QCDs. Also, it only applies to distributions from IRAs, not from other retirement plans like your 401(k) or 403(b).
One limitation of the QCD rules is the kind of charity that can be used for the QCD donation. The rules do not permit donations to donor-advised funds or a private foundation or a supporting organization under IRS Section 509(a)(3). Unfortunately, this means that donations to a Fidelity Charitable Giving account or Vanguard Charitable or any other donor-advised fund cannot be used for QCDs. However, most other 501(c)(3) charities do qualify.
The QCD rules limit these direct IRA donations to charity to $100,000 per year per person. If you are married, both spouses can donate up to $100,000 each, or $200,000 total. As this is a large amount, most people will not be limited by this rule.
For people with a basis in their IRAs, using QCDs will not use your basis on the amount donated to charity. This is another advantage of QCDs.
The basic result of using QCDs is that you have lower taxable IRA income and thus lower Adjusted Gross Income (AGI) shown on your tax return. If you only take the required distribution from your IRAs, you will be taxed on less than the RMD amount. By using QCDs, you reduce the taxable amount of RMDs you would otherwise have to withdraw. This provides many money-saving advantages in various tax situations as discussed below.
Savings When the Standard Deduction Is Used
The real “home run” created by QCDs is for people who take the standard deduction and do not use itemized deductions. The standard deduction is $27,000 for 2019 and other itemized deductions like taxes paid are limited under the new tax laws. Many more people will use the standard deduction compared to under the old laws in 2017 and before. QCDs will reduce the AGI on your tax return, and since the standard deduction is not affected, it lowers the taxable income and lowers your taxes. For example, if you donate $5,000 to charity, use the standard deduction, and you are in the 22% tax bracket, using QCDs will save you $1,100.
Savings When Social Security Is Not Fully Taxable
The “grand slam home run” created by QCDs is for people using the standard deduction and whose Social Security income is not fully 85% taxable after the QCDs are used. The taxable amount of Social Security is based on how much other AGI you have on your tax return. So when you lower your AGI with QCDs, less of your Social Security is taxable.
Here is a simple example of the grand slam QCD. Suppose a single person over age 70½ has 2019 income of only $30,000 from Social Security and $40,000 RMDs from traditional IRAs. This person donates $4,000 to charity but still must take the standard deduction of $13,850 because there are not enough other itemized deductions. The federal income tax would be $6,529 without using QCDs. By jumping through the IRS hoop to donate the $4,000 directly from the IRA account, the tax falls to $4,901 creating a tax savings of $1,628―over 40% of the donated amount! Helping to create this savings is the decrease in taxable Social Security income from $22,350 without using QCDs, to $18,950 with QCDs.
Savings When Using Itemized Deductions
Medical expenses that are itemized deductions on your Schedule A are phased out by a percentage of your AGI. Medical deductions are phased out by 10% of your AGI in 2019. In prior years, miscellaneous itemized deductions were phased out by 2% of your AGI, but these are no longer deductible under the new tax law. By using QCDs, if you itemize with medical deductions, you reduce your income and AGI. You lower your charitable deduction somewhat which offsets the QCD savings, but the medical deduction phase-out is reduced which saves you taxes when using QCDs. Ignoring the potential savings from Social Security taxability as discussed above, a QCD for a similar taxpayer in the 22% tax bracket will save $88 on the $4,000 QCD by lowering that medical deduction phase-out.
Savings on Medicare Premiums
Nearly all people age 70½ are on Medicare. The premiums for Part B and sometimes Part D are usually deducted from their Social Security payments. If your Modified AGI (MAGI, which includes tax-exempt interest) is over a certain amount, these Medicare premiums will be raised for one year in the future.
For example, for married couples, the first threshold is now $174,000 of MAGI using 2020 rules. If the couple’s MAGI was $176,000 in 2018, the 2020 Medicare premiums would be increased for each spouse by $57.80 per month for Part B and $12.20 per month for Part D. This is $1,680 extra cost for 2020. If you were going to have just over $174,000 of MAGI, using QCDs to lower your MAGI below that amount will provide great savings―at no real cost if you planned to donate to charity anyway.
There are additional 2020 thresholds of increased Medicare premiums at MAGI levels of $218,000; $272,000; $326,000 and $750,000. The increases in Medicare premiums B and D are larger at each of these thresholds and are $2,546.40 more at each threshold for 2020 for a married couple using both Parts B and D. Using QCDs to get under these thresholds saves even more money.
Savings for Higher Income Taxpayers Subject to NII or AMT
Higher-income taxpayers with AGI over $250,000 (married couple) face additional taxes from the Net Investment Income (NII) tax which causes an extra 3.8% tax on investment income above that amount of AGI. If the $4000 QCD reduces the investment income subject to this tax, it saves an extra $152. Although it is now rare to be subject to the Alternative Minimum Tax (AMT), it is possible that QCDs could save on AMT for those subject to it.
Improved Roth IRA Strategy
QCDs can help in the Roth conversion planning process. Some people want to make Roth conversions but only up to the point where their Medicare premiums will not increase based on MAGI. Since MAGI is reduced by using QCDs, more can be converted to Roth IRAs.
If you are still getting some employment or self-employment income after age 70½, you may be able to make Roth IRA contributions. There are AGI based income limits on doing this. Roth IRA contributions are limited if AGI is over $122,000 for a single person or $193,000 on a joint return. Using QCDs lowers AGI and can help to qualify you for more Roth IRA contributions (if you were facing the limitations).
Various Other Benefits of QCDs
Without getting too much more involved in the tax code, there are many other ways QCDs can benefit you by reducing your AGI. Certain deductions and credits are limited by higher AGI. A tax credit example is the lifetime learning credit for retirees who are taking some college courses later in life. Using QCDs may help you qualify for the credit. A deduction example is the rental loss deduction that can become limited if your income is over certain amounts. Using QCDs lowers your income and may allow a larger rental loss deduction.
No Downside or Costs of QCDs?
The minimal downsides of using QCDs are simply the procedures. There is no cost to using them. You must only send your IRA investment manager or broker the name and address of the charity and how much to donate. You will likely want to lower your other RMDs above the amount donated, so keep track of this. You will still need to get the documentation letters from the charities like you would have to do on any other charitable donation. You will have to keep track of the QCDs and tell your tax preparer you made them. If you prepare your own tax return, you must follow the rules on how to present the QCDs on Form 1040.
It may be a slight additional burden on the IRA broker to process a QCD distribution. Because of the additional paperwork, you may want to use QCDs only for the larger contribution amounts. You may even want to “bunch-up” your charitable donations for the year, or even for two years at a time, to take advantage of the standard deduction and other advantages mentioned above.
Because there are no significant disadvantages and no costs of using QCDs, you should use them to make your charitable donations if you are over age 70½. If it is early in the tax year, you may not even be aware of how they will save you money for the current year.
I know this is a lot of technical information, and it is a shame the IRS makes you “jump through hoops” for QCDs instead of just allowing you deduct all your charitable donations from IRA income. But why not take a small jump and find out from your tax advisor if you would see any potential savings. It certainly makes sense if you were going to make the charitable donations anyway!
This handy tax card has been helping investors—and most especially our clients—save time and money since 2005. Without fail, it is the most popular item our office produces. It is requested by attorneys, accountants, financial advisors, judges, as well as our clients and friends. We receive requests for the card from all over the country! Please download and print your copy at paytaxeslater.com/taxcard.
What might not be apparent at first (because the card doesn’t show the 2017 tax brackets) is the tax bracket for married taxpayers with income between $168,401 and 321,450. It is at an all-time low of 24%. We do not have a crystal ball, but we suspect these historically low rates will not last forever. This presents potential significant Roth IRA conversion opportunities for two groups of taxpayers.
- Taxpayers who were good candidates for Roth IRA conversions who now might be good candidates for increased Roth IRA conversions.
- Taxpayers who were previously not good candidates for Roth IRA conversions but now because of the new low rates are good candidates for Roth IRA conversions.
The benefits of the new lower rates may apply to all taxpayers for the purposes of Roth IRA conversions, but the rates for married taxpayers are particularly advantageous. Roth IRA conversions are more important than ever in the shadow of the SECURE Act. Please see Chapter 5 of my book, Retirement Plan Owner’s Guide to Beating the New Death Tax, that you should have received in the mail. If you have not received your copy of this book, please call 412-521-2732, and Alice will be happy to mail.
That said, the tax card can only offer a rough guide to optimizing your tax strategy. For example, a quick look might make it seem like Roth IRA conversions will be advantageous, but after you take other taxes into consideration for instance, additional premiums for Medicare Part B, the differences in capital gains taxes and qualified dividends and interest income, it may not be favorable. You can’t rely on the tax card without a much deeper analysis for Roth IRA conversions as well as many other tax planning techniques.
If you would like additional information on our classic Roth IRA conversion strategies, please download our classic Roth IRA conversion book, The Roth Revolution, Pay Taxes Once and Never Again at https://www.paytaxeslater.com/articles/roth_revolution.pdf.If you would like help developing a long-term Roth IRA conversion strategy as well as developing your own Financial Masterplan as described at the end of Retirement Plan Owner’s Guide to Beating the New Death Tax, please call Alice at 412-521-2732. Please understand, however, that we have no availability for new Financial Masterplans until after the new year.
Pittsburgh Post-Gazette Recognizes the Value of Lange’s Year-End Tax Report and Qualified Charitable Distribution Rules Article
Tim Grant of the Pittsburgh Post-Gazette recently spoke to Jim to ask his comments and recommendations on two topics related to taxes: year-end tax planning and charitable contributions from IRAs.
Tim’s article, TAX PREPARATION: A few year-end strategies can help lower your 2019 bill, was published Thursday, November 14th. Here is a link to the full P-G article: paytaxeslater.com/PPG1. If you would like to read our full report on year-end tax strategies, here is the link: https://paytaxeslater.com/2019yearendtaxplanning/.
The second article, A tool to meet the government’s IRA tax rules but also boost to charities was published Sunday, December 1st. Here is a link to the full P-G article: paytaxeslater.com/PPG2. You can also read the lead article in this newsletter, Use the QCD Rules to Save Extra Money on Charitable Donations if You Are at Least Age 70½.
We are always pleased when Pittsburgh Post-Gazette shares informative tax/investment articles with its readers. We are especially pleased when their reporters ask recognized experts, like Jim, to substantiate the information and provide additional insight. Our hope is that all readers will take action to save money on taxes. Here is our favorite quote from Judge Learned Hand: “Anyone may so arrange his affairs that his taxes shall be as low as possible; he is not bound to choose that pattern which will best pay the Treasury; there is not even a patriotic duty to increase one’s taxes.”
2020 Workshop Information
Saturday, February 1, 2020
Comfort Inn & Suites, Salon D
180 Gamma Drive, Bldg. B
Pittsburgh, PA 15238
or Saturday, February 8, 2020
Crowne Plaza Pittsburgh South, Keystone Room
164 Fort Couch Road
Pittsburgh, PA 15241
Reserve your seat today by calling 412-521-2732 to RSVP.
9:30 – 11:30 a.m.
The Best Estate Plan for Married IRA Owners Combined with Optimal Trust Planning for IRAs and Retirement Plans
1:00 – 3:00 p.m.
How to Stop Pending Changes in Tax Laws from Taking Up to 1/3 of Your IRAs and Retirement Plans in Taxes at your Death
3:15 – 4:00 p.m.
Solving the Investor’s Biggest Dilemma: How to Stop Market Volatility from Crushing Your Retirement Nest Egg in the Next Downturn