Donating to charity has many intangible benefits. Giving can help us feel better, connect to our community, and improve the lives of others. Of course, charitable giving can also provide tangible income tax benefits to individuals by allowing a deduction from income on their tax returns. This article explores one particular strategy for tax-efficient charitable giving for anyone over the age of 70 ½ and who has an Individual Retirement Account (IRA). For those eligible, donating IRA funds to charity through a Qualified Charitable Distribution (QCD) may yield the biggest tax bang for your charitable buck.
As you may be aware, the IRS requires taxpayers over age 70 ½ to take a Required Minimum Distribution (RMD) from their IRAs each year. This forced IRA distribution adds ‘taxable income’ to your annual income tax return – thus increasing the amount of taxes you pay to Uncle Sam at the end of the year. However, by utilizing a QCD (donating your RMD to charity, rather than cash), you can minimize your overall tax liability.
Any amounts given to charity using a QCD will count towards your IRA’s annual RMD, but will not be included in your taxable income.
Typically, the tax benefit of making charitable gifts is only realized by those who itemize deductions when filing their tax returns – not for those who file with a standard deduction. However, when you make a QCD, the distribution is instead automatically omitted from your adjusted gross income (AGI). This means the tax benefit from a QCD can be realized by all individuals – regardless of whether they take the standard deduction or itemize their deductions. This is GREAT news for anyone over age 70 ½ because many taxpayers in that age bracket take the standard deduction.
A direct reduction to your AGI has a ripple effect on your overall tax liability that can yield additional tax benefits:
- A lower AGI may trigger a reduction in taxable Social Security benefits and/or in future Medicare premiums.
- Lowering your AGI can help increase other potential itemized deductions, such as medical expenses or miscellaneous deductions. This is primarily due to the fact that these deductions must exceed a certain percentage of adjusted gross income before you can count them against your tax liability. Therefore, decreasing AGI creates a lower ‘hurdle’ before those deductions provide tax savings for you.
- Finally, depending on your state residency, using a QCD to lower your AGI may provide a reduction in your state income tax liability. This is a state tax savings that would otherwise not be received by taxpayers in states that do not allow itemized deductions.
To make a qualified charitable distribution (QCD) you must be over age 70 ½ and own an IRA account. A QCD will typically be made from a Traditional IRA account (versus a Roth IRA) and must go directly to a qualified 501(c)(3) organization (gifts to private foundations and donor-advised funds are not eligible for QCD treatment). Also, if you take advantage of utilizing this strategy, make sure you work with your tax preparer to ensure accurate reporting of the QCD on your tax return.
If you are over age 70 ½ and taking required minimum distributions (RMDs) from your IRA account – and if you plan to donate to charity, we recommend discussing the potential benefits of a QCD with your financial/tax advisor. A review of your unique circumstances, annual tax returns, charitable giving goals, and long term financial plan should all be reviewed to determine whether a QCD is a good gifting strategy for you.
Lisa Lawhorn is a Tax Advisor at Wealthquest, a Cincinnati-based financial planning and wealth management firm that offers a full range of financial services under one roof, for one simple fee.