Advisor Insights

An Easier Way to Make Qualified Charitable Distributions

Helen Modly, CFP, CPWA

A qualified charitable distribution is a nontaxable charitable contribution made directly from an IRA (except for an ongoing SEP or SIMPLE IRA) to a qualified charity. A qualified charity must be a 501(c)(3) organization. Private foundations, supporting organizations and donor-advised funds are not eligible charities for QCD purposes.

To be eligible to make a QCD, clients must be at least 70 1/2 and required to take minimum distributions from their IRA. They can contribute up to $100,000 per year to any combination of qualified charities. A QCD can satisfy all or part of their required minimum distribution amount for the year.

Why Make a QCD in the First Place?
This strategy has been popular among charitably inclined clients for quite some time because the amount of a QCD is not counted as taxable income. The client also will not get a tax deduction. Instead, the QCD is not reflected on the tax return at all. Thus, it does not raise the client's adjusted gross income. This is important because Medicare premiums, the floor for health expense deductions, and a host of other benefits are based on modified adjusted gross income, which is your client's AGI plus any tax-exempt interest received.

By keeping the IRA distribution off the tax return, your client may also avoid or reduce the amount of net investment income tax owed. This is the 3.8% tax on certain investment income for high-income-earners. The NIIT kicks in when modified adjusted gross income hits $250,000 if your client is married and filing jointly, $125,000 if your client is married and filing separately, and $200,000 if your client is filing as single or any other way.

The Normal Process
To implement a QCD, a client normally notifies the custodian of the specific charity he or she has selected, as well as the amount and date of the QCD. Most custodians have a form for this (some require a separate form for each donation). Others will require a medallion signature guarantee for QCDs over a certain limit. In addition, many custodians have a minimum QCD amount, such as $1,000. Funds can be wired to the charity or sent via check directly from the custodian. Wire transfers can be problematic, as often the client's name is not transmitted to the charity along with the gift. Your client must inform the charity that the contribution is coming and follow up afterward. Most of these transactions occur in the final weeks of the year, so the process can take longer than expected.

A Better Way
Clients can request a checkbook connected to their IRA account from the custodian. All of the main independent custodians offer this service. Clients then write a check, or as many checks as they want, to the selected charity or charities for whatever amount they wish and mail them off. They can include a letter with their contact information so the charity can easily provide an acknowledgement letter. Most custodians also supply an image of the cancelled check online for tracking purposes. An advisor will also be able to view the cancelled checks online.

Educate Your Clients about Their Responsibilities
Most importantly, it is the client's responsibility to ensure the charity qualifies as a QCD recipient. Charities will usually post their tax-deductibility status on their websites, or that information often can be found on the Charity Navigator website.

Your client should also obtain an acknowledgement of the contribution from the charity for audit purposes.

Potential Pitfalls
There are potential pitfalls to this method, so be sure to be sure to inform your clients about the following:

They will be responsible for meeting their RMD requirements as you, the advisor, will not necessarily know what contributions have been made but not yet cleared on the account. Encourage your clients not to wait until mid-December to mail out contributions. In our office, we inquire about charitable gift intent in the first week of November to get the ball rolling.

Advisors can provide clients with RMDs taken year to date in early November and work with them on a schedule to complete their RMD prior to mid-December.

The client will still be responsible for notifying their tax preparer of the QCD so it can be excluded from income on the tax return. If their returns are self-prepared, they report the full IRA distribution, and on the line for taxable amount, they report only the amount not a QCD, if any. Currently, form 1099-R does not have a code for QCD, so if your client fails to record it, it will be taxed.

For all but inherited IRAs, most custodians provide a notice toward year end of any RMD amount remaining. As noted, advisors should still confirm that clients have a plan in place to complete their RMDs before mid-December.

Empowering your clients to have more flexibility and control over the QCD process should enable them to make more spontaneous and smaller contributions to the causes that matter most to them. It can also eliminate a flurry of client service-related activity at the end of the year for you.

Helen Modly, CFP, CPWA, is a wealth advisor with Buckingham Strategic Wealth, a fee-only registered investment advisor. The opinions in this article are the author’s own and may not reflect the opinions of Buckingham Strategic Wealth or Morningstar.com. The author may be reached at nova@bamadvisor.com.