If the thought of future required minimum distributions worries you because you know what a tax burden it will create, you might consider qualified charitable distributions. QCDs are a way around required minimum distributions (RMDs) while allowing you to support your favorite charities.
They aren't for everyone, and only certain taxpayers and charities qualify. Here's everything you should know about a qualified charitable distribution.
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What Is a Qualified Charitable Distribution?
A qualified charitable distribution, QCD, is a distribution made from your IRA to a qualified charity. The distributions can start at age 70 1/2 and count toward your required minimum distributions, even though they don't officially begin until age 73 or 75, depending on when you were born.
How They Work
The QCD rules say you can make qualified charitable contributions from traditional or Roth IRAs. Still, it makes more sense to contribute from a traditional IRA to get the tax benefit. You make a direct transfer from your qualifying individual retirement account to a qualified charity for it to work.
Lower Taxable Income
When you make a QCD from IRA, it is not taxable income, unlike when you withdraw the funds for personal use. Contributing from a traditional IRA makes the most sense because Roth IRA distributions aren't taxable income.
You aren't required to itemize deductions to lower your taxable income. Instead, you take the contribution off your gross income, even if you only take the standard deduction.
Qualified charitable distributions count toward your required minimum distributions, which helps reduce your taxable income. When you take RMDs, you must pay taxes on the income distribution, which can be a financial burden.
However, you can make up to $100,000 in QMDs per year, the maximum annual amount. This reduces the amount of RMDs you must take and your tax liability.
How to Qualify
If you have a qualifying IRA, you may be eligible for QCDs if you meet the following:
- You must be at least 70 1/2 years old
- You may contribute up to $100,000 to combined charities
- The funds must be contributed by your annual RMD deadline, usually the end of the year
Eligible IRA Accounts
The eligible IRA accounts include the following:
- Traditional IRAs
- Roth IRAs (not common)
- SIMPLE IRAs
- SEP IRAs
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How to Make Qualified Charitable Donations
How you make a qualified distribution depends on your brokerage and how they handle distributions.
Some, like Schwab, allow you to set up automatic transfers. You can schedule the transfers throughout the year and even to multiple charities if you want to give to several charities throughout the year.
You can write checks directly from your IRA if you prefer to write checks yourself. However, this method requires you to watch the timeline and be sure you meet all deadlines. Writing checks multiple times a year or to multiple charities can be more work, but some people prefer the more personal touch for charitable giving.
However, use caution when writing checks if you write them near the end of the year. You can't control when the charity cashes the check, and that's when it counts as a QCD. For example, if you write a check on December 15 to an eligible charity, but they cash the check on January 15, you won't get the credit for the QCD in the previous year.
Not all charities count for QCDs. First, they must be a registered 501(c)(3) and be able to receive tax-deductible contributions.
Your tax professional knows best which charities count and which don't, but here are some of the exclusions:
- Private foundations
- Donor-advised funds
- Supporting organizations
QCDs and Taxes
QCDs are not subject to income taxes as long as you contribute less than the annual limit ($100,000). However, there are some factors to consider.
You don't itemized deductions to get the IRA-qualified charitable distribution benefit. You don't pay taxes on the contribution at the federal level. However, you cannot claim the charitable giving for another tax deduction.
When you take a qualified charitable distribution, QCD, you reduce your taxable income, which is helpful for retirees who are subject to required minimum distributions. Rather than paying the taxes on the income, you can offset some of the responsibility by making tax-free QCDs.
You aren't receiving a tax deduction for the qualified charitable distribution from IRA. Instead, the income isn't considered taxable income. However, you cannot take any tax deductions regarding the income, including a charitable contribution deduction.
At the state level, how you're taxed depends on the state laws. Some states require that you add the income back into your gross income and pay applicable taxes. Each state differs, so discuss it with your tax advisor.
You don't have to pay federal taxes on QCDs up to the annual limit. Currently, the limit is $100,000, but it will change in 2024 according to the Secure Act 2.0.
Reporting Qualified Charitable Distributions
To report your IRA charitable distribution, you will use your 1099-R, which displays the distributions you took from your IRA for the year. However, your 1099-R won't break down how much you withdrew for yourself and how much was for a QCD.
On your 1040, you'll input the total distribution, including any QCDs, and underneath it, report any portion of the distribution that was not a part of the QCD. That's the income you'll pay taxes on.
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Jim has an annual retirement income of $75,000 but is nearing the age where required minimum distributions will be necessary. Because of the size of Jim's retirement assets, his RMDs are $50,000 per year.
Jim doesn't need the income and plans to contribute it to charity. If he withdraws the funds as a personal distribution and then donates to charity, he'll pay state and federal taxes on the income but can then deduct the charitable contributions.
However, if Jim took the required minimum distribution as a QCD, the distribution would be tax-free, but he couldn't take the charitable gift deduction. So, after discussing it with his tax advisor, Jim decided he would save much more money by making a direct transfer to one or more charities of his choice.
Qualified Charitable Distributions Pros and Cons
All financial decisions have pros and cons. Understanding the good and bad can help you determine what's right.
- QCDs can reduce your adjusted gross income and your tax liability by avoiding putting you in a higher tax bracket when you take a required minimum distribution
- It doesn't matter if you itemized deductions or take the standard deduction; as long as you meet the age and contribution limit requirements, you may be eligible
- You can avoid the penalty for not taking RMDs while putting your money to good use
- You can support your favorite charities
- Not all charities qualify; you must ensure the organizations you support are approved, or you could risk losing the tax benefits
- If you withdraw funds first and then contribute to charity, you must pay the taxes on the income and only get the charitable contribution deduction
- You can't contribute more than $100,000 per year (until 2024)
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Qualified charitable distributions may help you save on your tax liabilities, but you should always consult with your tax advisor.
What Is the Maximum Contribution for a QCD?
For 2023, the maximum contribution for a QCD is $100,000, but the limit will increase in 2024 to keep pace with inflation.
Are All Charitable Organizations Eligible for Charitable Donations via QCDs?
Not all charities are eligible for charitable donations via QCDs. They must meet specific requirements, such as being a registered 501(c)(3), and they cannot be private foundations or donor-advised funds.
Are Any Additional Forms or Paperwork Required for QCDs When Filing My Taxes?
You'll receive a 1099-R when you have IRA distributions; your tax advisor will help you determine how to report them to report your taxes properly.
The Bottom Line
Qualified charitable distributions may help lower your tax liability while ensuring you follow the Required Minimum Distributions requirements. In addition, qualified charitable distribution rules make it easy to offset your taxable income while meeting your retirement distribution requirements in the calendar year.