The Value and Complexity of Qualified Charitable Distributions (QCDs)

For close to ten years, tax law rulings surrounding the Qualified Charitable Distribution (QCD) from an Individual Retirement Arrangement (IRA) to a charitable entity have flip-flopped as the tax code has grown and been modified over the years. But in 2015, the Protecting Americans from Tax Hikes (PATH) Act finally made the rules surrounding the QCD permanent, allowing individuals to give charitably while also minimizing income taxes from the Required Minimum Distribution (RMD).

QCDs allow for organizations doing noble and impactful work to garner financial support in a tax efficient way. When a QCD is successfully done, an individual can gift up to $100,000 per year from their IRA account directly to charity and have these funds excluded from taxable income as opposed to taking an itemized tax deduction when gifting these funds secondarily to charity. For your convenience, a summary of QCD benefits is highlighted below:

-          QCD distributions are not included in Adjusted Gross Income (AGI)

o   Can be advantageous by keeping income lower which may increase the likelihood of eligibility for tax credits and deductions including Medicare and Social Security

o   Doesn’t require you to itemize your deductions which will allow for claiming the Standard Deduction while still receiving the benefit of the gift

-          QCDs can count toward the RMD for up to $100,000/year

o   Note that any amount distributed above the RMD will not be eligible to count towards the next year’s RMD

-          Performing a QCD may allow for the bypass of the percentage of AGI gifting rules which may allow for a higher percentage of income to be given and deducted in a single year than otherwise allowed

-          Distributions for a QCD are all deemed to be the taxable portion of an individuals aggregate IRA portfolio versus the typical pro-rata rules for typical distributions.

Due to the tax-advantaged nature of QCDs, there naturally are many limitations and specific requirements that need to be met in order to perform this gifting strategy. This article seeks to cover this topic in greater detail and provide additional clarity on the matter.

Qualified Charitable Distributions would not be possible without the use of the Individual Retirement Arrangement (IRA). IRAs allow for an individual to save money for retirement in a tax advantaged way. There are two types of different tax advantages that separately allow you to receive preferential tax treatment. The two broad categories of advantageous tax treatment are covered in greater detail below:

1.       Traditional

o   Contributions made are generally tax-deductible and grow tax-deferred until withdrawn from the account. At that point, any principle and growth are taxed at ordinary income tax rates.

2.       Roth

o   Contributions made are already taxed prior to entering the account which allows for any withdrawals of both principle and growth to be tax-free.

Whether an individual chooses to save via Traditional or Roth tax treatment, the tax benefits allow savings to potentially grow, or compound, more quickly than in a taxable account. Although QCDs are possible from both Traditional and Roth IRA accounts, this article will focus on distributions from Traditional IRAs because distributions from Roth IRAs are already tax-free and not relevant for the tax-advantageous nature of this gifting strategy. Additionally, further rules surrounding the QCD state that this strategy is allowed from SEP and SIMPLE IRAs, however it is only allowed after there are no additional contributions. Note that QCDs are also excluded from 401(k) account and other employer plans although this problem can be solved by transferring funds to an account such as a rollover IRA where the QCD is allowed.

Age restriction rules surrounding the QCD state that the account owner must be age 70.5 or older at the time of distribution. As some background, this rule recently aligned with the Required Minimum Distribution age of 70.5 until the SECURE Act (passed in December, 2019) adjusted the RMD age to 72. This act however did not adjust the QCD eligibility age which remains at age 70.5.

Additionally, for a QCD to qualify it is also stipulated that a public 501(c)(3) charitable organization must receive the distribution as opposed to a Private Foundation or Donor Advised Fund. These types of entities are excluded from QCD eligibility as stated in IRC Section 170(b)(1)(A).

A common question surrounded by a fair bit of confusion is whether a QCD is allowed from a non-spousal beneficiary IRA. As some background context, a beneficiary IRA is an IRA that was inherited after the death of the original IRA owners. It is fairly common for a spouse to receive these assets, however, it is also common for non-spouses to also be listed. In instances where there is a non-spousal beneficiary IRA, the account owner IS allowed to make a QCD from the IRA as long as all of the above criteria is also met which includes their age being above the age 70.5 limitation.

The process of making a successful QCD isn’t explicitly complicated however it’s imperative that it’s done correctly in order for a QCD to be achieved. Below is a broad overview of the process:

1.       Submit a distribution request to your investment advisor or custodian, with the check being made payable directly to the desired charity

a.       This is critical because funds will need to be transferred directly to the charity. If they are first deposited into an individual’s account before being passed to the charity the QCD will be disqualified.

2.       When requesting the distribution, be sure to elect that no tax withholding is being done on this distribution

3.       Send the check directly to the qualifying charity. In the event that the custodian can only send a check directly to the IRA owner, have the check immediately forwarded to the desired charity. As stated above if the funds are deposited anywhere but to the charity, the QCD is disqualified.

4.       The QCD is deemed to have occurred during the year in which the check is cashed, and funds are distributed to the charity. Because this final step may take some additional time, please ensure adequate lead time.

QCDs provide a great opportunity for charitably minded individuals to financially support causes they believe in while being tax-efficient along the way. Although the rules behind this strategy can seem complex and confusing, successful navigation of them allows for individuals to have more funds go to charities, everything else held equal. Please consult your tax professional for more information about how a QCD may impact you.

Please do not hesitate to reach out to us with any further specific questions you might have.