What Are Qualified Charitable Distributions (QCDs)? - Charitable gifts made directly from an IRA can provide added tax benefits for many taxpayers, but they aren't right for everyone.
The Qualified Charitable Distribution (QCD) rules allow taxpayers to make IRA distributions payable directly to a qualified charity without treating the distribution as taxable income. This law permits up to $100,000 per eligible IRA owner to be contributed directly from their IRA to charity. In addition, the distribution can be used to fulfill the IRA owner's Required Minimum Distribution (RMD) for the year. The initial QCD rules were intended to expire after 2007, but they were reenacted periodically over the years. The Protecting Americans from Tax Hikes (PATH) Act of 2015 made these rules a permanent part of the tax code.
In order to be considered a Qualified Charitable Distribution, the following conditions must be met:
The amount distributed to the charity is not limited to the RMD amount for the year, nor does the distribution have to be the RMD. IRA owners can withdraw – and keep – their RMD and still make additional distributions to charity from the account.
Prior to the QCD rules, a taxpayer could take a distribution from their IRA (which would be included in their Adjusted Gross Income, or AGI), donate the same dollar amount to a charity, and offset the IRA income by claiming an itemized deduction for the donation. These two amounts would offset each other and there would be no net impact on the taxpayer's taxable income. For an IRA distribution treated as a QCD, however, the taxpayer neither reports the income as part of their AGI nor claims a charitable deduction. This treatment may seem to provide the same tax benefit as just donating the cash from the RMD, but it does offer some unique benefits.
While there are certainly cases where a QCD transaction provides a real tax benefit to the IRA owner, there are also cases where keeping the RMD and giving appreciated securities to charity will be a better tax strategy. For example, assume a taxpayer is considering two options:
Gifting $30,000 from their IRA to charity, via the QCD, and then selling $30,000 of stock to fund their spending needs.Withdrawing $30,000 from their IRA to fund their spending needs, but then donating $30,000 of stock to charity and taking a tax deduction for the gift.
The first column in the table below shows the tax impact of keeping the RMD and donating the stock to charity. The next four columns show the tax impact of giving the RMD to charity but then selling the stock, assuming different cost basis amounts and therefore different capital gains upon the sale.
As this table shows, the greater the gain on the stock held by the taxpayer, the greater the tax benefit of donating that appreciated stock rather than donating the RMD and then selling the stock. In other words, taxpayers who use their RMD to cover their living expenses but also want to make charitable gifts may be better served by keeping their RMD and donating appreciated stock they own.
On the other hand, if the taxpayer plans to hold the stock until death (thereby receiving a basis adjustment and eliminating the gain) or otherwise has no need for their RMD, then the QCD technique becomes more attractive. Also, those required to take smaller RMDs from their IRA or in a lower ordinary tax bracket will see less of a difference between these two techniques.
Taxpayers doing a QCD transaction should be aware that the custodian of the IRA will still report the distribution from the IRA as a regular withdrawal. The IRA owner will receive Form 1099-R reporting the entire distribution from the IRA, including the QCD, which should then be reported on line 4a of their Form 1040. On line 4b, the IRA owner will then enter the difference between the entire distribution amount and the QCD amount. The IRA owner should then write “QCD” next to line 4b identifying that the difference between the line 4a and 4b amounts is tax-free under this exception.
Robert W. Baird & Co. Incorporated. Baird does not provide tax advice. Please consult with your tax advisor.