The Wisdom of Contributing to a Charity Directly from an IRA
by Gregory S. Dowell, CPA
A client recently asked me about making charitable gifts directly to a charity from his IRA. This can be a great strategy in the right cases, although it will tend to appeal to a limited number of taxpayers. It does merit further analysis, however, and this brief article will be dedicated to giving the reader more information to help determine when and where it might be appropriate to make charitable contributions directly from their IRAs.
The general provisions are that taxpayers who are age 70 1/2 are eligible to make gifts directly from their IRAs (traditional or Roth) to qualified charities. All three of those elements are critical:
1) taxpayers must be age 70 1/2,
2) gifts to charity must be made directly from the retirement account to the charity, and
3) the recipient must be a qualified charity (an organization that would qualify as a charitable organization under Sec. 170(b(1)(a), other than a private foundation or donor advised fund).
These qualified charitable distributions (“QCDs”) are limited to $100,000 per taxpayer per year. This provision was originally available in 2006, and has been extended over the years until it was made permanent in the Internal Revenue Code in 2015 (it is unknown at this time if the promise of tax reform in the next few months will affect this provision). These QCDs were neither included in the individual’s income nor allowed as a charitable deduction for the tax year. Except for the need to disclose the transaction on form 8606 and on the retirement account distribution line of the tax return (which ultimately reports no taxable income from the distribution), the QCD has no effect on the taxpayer’s tax return.
Even without the charitable deduction, QCDs are a tax-efficient means of making charitable donations because the transfer did not increase the individual’s adjusted gross income (“AGI”). Avoiding increases to AGI can be important in many cases, because some income and deduction items are triggered by the AGI. For instance, as AGI increases, it can result in more of a taxpayer’s social security becoming taxable. Similarly, an increase in AGI can result in less of a taxpayer’s medical expenses becoming deductible. Furthermore, the phasing out of itemized deductions for those taxpayers with higher AGIs will result in some taxpayers being limited as to the amount of charitable contributions that they can actually deduct; for instance, a gift of $100,000 may only result in a tax deduction of $95,000.
QCDs can also expand the amount that taxpayers can give to charities on an annual basis. Taxpayers are limited to deducting cash charitable contributions that are 50% or less of their AGI; any excess contributions are carried over to the following year, where they again go through the same 50% of AGI limitaion. QCDs can expand the effective amount of charitable giving because the amount donated to a charity directly from an IRA does not count toward the 50% limit. Again, a QCD results in no income and no deduction on the taxpayer’s tax return. While the QCD does not result in a tax deduction on the taxpayer’s tax return, when a taxpayer makes a QCD, it is effectively the same as making a charitable contribution that is 100% deductible.
Another interesting feature of the QCD is that it can be used to satisfy the taxpayer’s required minimum distribution for the year (remember that a taxpayer is required to take a minimum amount from his/her retirement accounts each year once the taxpayer reaches age 70 1/2).
QCDs clearly apply to taxpayers who have a significant amount of assets and who are charitably inclined. So when are QCDs most appropriate? I believe they are most appropriate for taxpayers who have some of these characteristics:
- Want to make gifts to charity that would be in excess of the 50% limit of AGI;
- Are not counting on the funds in their retirement plans as a means of support (in other words, the taxpayers have plenty of other assets to support them and can afford large charitable gifts), so that the required minimum distribution can be re-directed to charity;
- Are not currently able to itemize their deductions and must take the standard deduction;
- Might be subject to limitations on their itemized deductions due to a high level of AGI;
- Might be subject to tax on their Social Security benefits if they take distributions from their IRAs.
Again, QCDs are clearly not for everyone but, for those who have considerable assets and are inclined to donate to charities, QCDs are definitely an option worth considering.