As 2018 comes to a close, many taxpayers are considering year-end charitable gifts and, for taxpayers 70 ½ or older, confirming they have satisfied the required minimum distribution (RMD) from their individual retirement account (IRA). While all of this is pretty standard, the Tax Cuts and Jobs Act (TCJA) presents a new opportunity for taxpayers to maximize their tax efficiency.
Effective in 2018, the TCJA increases the standard deduction for married taxpayers to $24,000 ($12,000 for single filers) – almost double that of 2017 ($12,700 and $6,350). In addition, miscellaneous itemized deductions were eliminated and the deduction for state and local income tax payments was capped at $10,000. This means that despite generous year end charitable giving, far fewer taxpayers will itemize their deductions in 2018 and will instead utilize the higher standard deduction. Utilizing the standard deduction eliminates any tax benefit ordinarily derived from charitable giving.
To retain this tax benefit, many taxpayers are considering making Qualified Charitable Distributions (QCDs) from their IRA before year end. A QCD is an otherwise taxable distribution from an IRA, owned by an individual who is age 70 ½ or over, that is paid directly from the IRA to a qualified 501 (c) (3) organization. QCDs are not considered taxable income to the account holder and they help satisfy the annual RMD. QCDs are not deductible as itemized deductions on the taxpayer’s individual income tax return, however, because they don’t increase taxable income. QCDs essentially provide a tax deduction and still allow taxpayers to benefit from the new, higher standard deduction.
IRA owners and beneficiaries are eligible to make a QCD, so long as the distribution is made on or after the date the taxpayer reaches age 70 ½. Simply making a distribution in the year the taxpayer turns 70 ½ is not sufficient. Distributions can be made from traditional, or SEP and SIMPLE IRAs that are not ongoing. An ongoing SEP and SIMPLE IRA are ones with active employer contributions in the year in which the charitable contributions are made.
To make a QCD, instruct the trustee of your IRA to make a direct contribution to an eligible 501 (c) (3) organization. It is important to insist the check is made payable to the charity directly and is not first payable to the owner or beneficiary of the IRA. If the check is first made to the taxpayer and then passed on to the charity, the requirements for a QCD are not met. Ensure that adequate records of the contribution are received to support the QCD.
On December 7, 2018, Steve, age 72, advised the trustee of his IRA to donate his $10,000 RMD directly to a qualified 501(c) (3) organization. Because Steve was 70 ½ at the time of the distribution and he directly contributed funds from his IRA to a qualified organization, the $10,000 is a QCD and is not included in his taxable income. Steve and his spouse file a joint tax return and their 2018 itemized deductions consist of $8,000 of state tax payments so they will not itemize their deductions in 2018.
If Steve would have withdrawn $10,000 from his IRA and written a $10,000 personal check to the same charitable organization, he would have been required to pay income tax on the IRA distribution and, because his increased charitable deductions of $18,000 would still not have exceeded the $24,000 standard deduction, he wouldn’t have received tax benefit from the contribution. By choosing to utilize the QCD rules, Steve saved tax at his marginal federal rates on the $10,000 IRA distribution, satisfied his RMD requirement and still benefitted from the increased standard deduction. For a taxpayer in the 22% federal tax bracket, this represents $2,200 of federal tax savings.
Every taxpayer’s situation is different, so please contact your tax advisor to determine if making a QCD is the right choice for you.