Strategic Giving

By Helen Modly, CFP, CPWA, and Jessica Jarosik, CFP, EA

One overlooked tax-saving strategy for charitably inclined individuals 70 1/2 and older is a qualified charitable distribution. Normally, come age 70 1/2, Uncle Sam requires all individuals who have diligently saved and reaped the benefits of tax-deferred retirement accounts to start taking required minimum distributions from such tax-advantaged accounts so these dollars can finally be taxed. RMDs are ordinary income, and this additional income may push clients up into a higher tax bracket and/or reduce their eligibility for credits and deductions. The QCD strategy provides a more tax-efficient way of making an impact on the charities that clients already donate to.

A QCD is a direct transfer of funds from an IRA account, payable to a qualified charitable organization of choice. The QCD will count toward the client's RMD for the year, and because the funds were sent directly to the organization, the tax code allows them to exclude the amount transferred to charity from their income. They cannot, however, double dip, so clients will not be able to deduct the contribution (or contributions) as an itemized deduction because it has already been excluded from their income.

Who Can Benefit? Because QCDs bypass the 1040, most all clients will benefit from the ability to reduce or keep their income at a desired level while also accomplishing their giving goals. Some specific situations include:

Individuals who claim the standard deduction: A retired couple with modest retirement income and no mortgage, and that does not have large medical bills or miscellaneous deductions, likely would not exceed the standard deduction, which currently is $12,700 for couples filing jointly for 2017. By donating via the QCD strategy, they would be able to take advantage of the excluded income, and, therefore, reduce their tax bill.

Itemized deduction and exemption eligibility: Several itemized deductions, such as medical/dental costs and job/miscellaneous costs, can only be taken when they are above a certain percentage of adjusted gross income. Additionally, higher earners--individual filers with more than $261,500 adjusted gross income and married joint filers with more than $313,800 ($156,900 if filing separately)--are even more limited, to the point they could phase out, not only on itemized deductions, but on personal exemptions as well. Reducing adjusted gross income through QCDs would allow these individuals to take advantage of the larger deductions and exemptions.

Avoid increased Medicare premiums: Both Medicare Part B and D are based on modified adjusted gross income. Currently, the lowest "bracket," in which the Medicare Part B premium is $134 per month, is for individual filers with less than $85,000 modified adjusted gross income and joint filers with less than $170,000. Just one additional dollar would bump the premium to $187.50 per month for an entire year--and that is just the difference for the lower two brackets! By making QCDs a part of a client's tax strategy, especially if they are on the border of two brackets, you could help them save a significant amount on Medicare premiums.

Reduce taxation of Social Security benefits: Because the IRS uses combined income (adjusted gross income+ nontaxable interest + 1/2 Social Security) to determine taxation on Social Security benefits, individuals near the lower end of a bracket would benefit from utilizing QCDs just enough to bring their combined income down to the next bracket, lowering the taxability of their Social Security benefit and their overall tax bill.

Reduce or eliminate long term capital gains rate: Taxpayers near the capital gains threshold would benefit from utilizing QCDs to reduce or eliminate their capital gains tax rate. For example, if a client is close to the bottom of the 25% bracket and makes a QCD large enough to drop into the 15% bracket, capital gains would be eliminated for the year.

State taxes: Because federal forms flow through to most state tax forms, reducing federal adjusted gross income through QCDs would reduce state adjusted gross income, resulting in decreased state tax liability as well.

The very charitably inclined: Retirees who make large charitable gifts on a regular basis may be limited by IRS charitable deduction limits, currently 50% of for cash/property donations to qualified charities. However, 20% and 30% limitations may also apply depending on type of donation and organization. QCDs are not subject to these limits, and would give individuals the option to exclude up to $100,000 of IRA donations from income.

Eligibility One of the main reasons this strategy has been overlooked is because, in prior years, we would have to wait to see if Congress was going to reauthorize the QCD provision for the current year, which would typically take place in December amid the end of year/tax-planning/holiday scramble. Fortunately, the provision was made permanent with the passage of the Protecting Americans from Tax Hikes Act of 2015, so you can proactively help clients incorporate QCDs as part of their tax planning.

Rules

• Individuals must actually be at least 70 1/2--not turning 70 1/2 that year--at the time the QCD is initiated.

• Distributions must be made directly from your IRA custodian/trustee to the qualified charitable organization. Be sure the check is made payable to the organization or electronically sent to the organization's bank account. If it's not sent directly to the organization, it will be a taxable event.

• Under QCD rules, a qualified charitable organization is a public charity as detailed in section 501(c) (3) of the Internal Revenue Code. Private foundations or donor advised funds are not qualified organizations. Individuals must also not receive any financial benefit, such as kickbacks, from the charitable organization to which the donation is being made.

• The maximum annual exclusion for QCDs is $100,000. This limitation is on a per-taxpayer basis, so for those who are married and filing jointly, both spouses can distribute $100,000 via QCDs from their respective IRAs.

• For QCDs to count toward an RMD for any year, it must be distributed with enough time for the organization to process the donation, typically Dec. 31 (or the last business day in December). You will want to confirm with your custodian the cut-off dates for guaranteed processing.

• Eligible account types: Traditional/rollover IRAs, inherited IRAs, and inactive SEP or SIMPLE IRAs.

Tax Filing When it's time to gather tax forms and file, the reporting for a QCD transaction may be confusing for some clients, so you will want to be sure to explain that their IRA custodian will include the QCD as a normal distribution on their year-end tax form, Form 1099-R, and that the difference between box 1, Gross Distribution, and box 2a, Taxable Amount, should include the QCDs they made that year. Also remind clients to keep an acknowledgement of the donation from the charity for their tax records.