7 Reasons Why All Investors Over Age 70 1/2 Should Consider a Qualified Charitable Distribution

This article is original content written by Manchester, CT Financial Advisor Thomas Scanlon, CFP®, CPA

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Our observation is that many people are very generous with the donations they make.  It sure helps that there is likely a tax deduction for this, no question.  Many people are accustomed to donating cash, writing a check to the charity or putting the donation on their credit card.  Let’s take a look at another technique you should consider.

Qualified Charitable Distribution

The tax code has a provision that allows another option for some people in how they can make charitable donations.  People over age 70½ with an IRA who are charitably inclined have an additional option available to them.  Individuals over age 70½ can exclude from income up to $100,000 a year in IRA distributions if it’s distributed directly to a qualified public charitable organization.  This is called a Qualified Charitable Distribution (“QCD”).  A qualified public charitable organization typically includes non-profit organizations recognized by the IRS under code section 501(c) (3).  A 501(c) (3) organization is operated for religious, charitable or scientific purposes.  Donors who make charitable contributions to these organizations are normally allowed a federal income tax deduction if they itemize their deductions.  A qualified public charitable organization however doesn’t include contributions made to donor advised funds, private foundations and supporting organizations.

No Double Benefit

Understand however that there is no double benefit allowed.  If an IRA distribution qualifies and an election is made to exclude it from income then there is no charitable donation deduction.  A Qualified Charitable Distribution from an IRA counts towards the annual Required Minimum Distribution (“RMD”).  Taxpayers over age 73 must begin to withdraw annually from their IRA and 401(k) accounts.  IRA’s and 401(k)’s are tax deferred accounts.  Funds are contributed and a tax deduction is allowed.  The funds in the IRA or 401(k) plan grow through the years without being taxed.  It’s when the funds are withdrawn that they are taxable as ordinary income. The IRS has a table to calculate what needs to be withdrawn.  Most folks will use IRS Table III (Uniform Lifetime).  The amount is based on the fair market value of the account from the prior December 31st balance.  Essentially the amounts are withdrawn over your life expectancy.  Keep in mind the RMD is the minimum amount that must be withdrawn.  If you need to, you can always take our more. Just be cautious, you don’t want to outlive your assets.  Taking your RMD is crucial.  Failing to take your RMD will result in a penalty of 50% of the amount that should have been withdrawn.  That is not a typo.  The penalty is 50%. Make sure you are taking your RMD annually.

Why should you consider doing this?  There are seven reasons to consider this strategy:

1) Taxpayers who don’t itemize their deductions aren’t getting any income tax benefit from their charitable donations.  Taxpayers can take either the standard deduction or itemize their deductions, whichever is larger.  The standard deduction for 2023 is $13,850 for single filers and $27,700 for married couples filing a joint return. It is estimated that 90% of income tax returns filed use the standard deduction. The major itemized deductions are for income and property taxes, mortgage interest and charitable donations.  Making a qualified charitable distribution from an IRA avoids having this included in taxable income and taxing it.

2) For taxpayers who do itemize their deductions, they may be subject to limitations on their charitable deductions.  The first limit is that cash donations (including checks and amounts put on your credit card) are limited to 60% of adjusted gross income (“AGI”). Appreciated property donations are generally limited to 30% of AGI.  Any amounts donated over this can be carried forward and deducted over the next five years.  Appreciated property is property that is worth more than your cost basis.  Your cost basis is generally what you paid for an asset.  For example, if you bought a stock for $10,000 and it was worth $15,000 when you donated it, this would be considered appreciated property.  If you inherit property your cost basis is generally the fair market value of the asset on the date of death of the person that passed away.

3) By making this election, AGI will be lower as this distribution isn’t included in income.  This may increase the allowable amount of medical deductions and miscellaneous itemized deductions as these deductions are limited as a percentage of AGI. Medical deductions are allowed for most folks when they exceed 10% of AGI.

4) A Qualified Charitable Distribution from an IRA reduces gross income and may be reducing the taxable portion of any Social Security benefits.  Social Security benefits may be taxable.  For a married couple filing a joint return they will have their Social Security benefits taxable when their modified adjusted gross income exceeds $32,000.  When the income exceeds $44,000 up to 85% of your Social Security benefits are taxable.

5) Some states income tax is based on AGI.  Therefore, taxpayers making this election may also be reducing their state income tax. The starting point for the State of Connecticut Income tax is Federal Adjusted Gross Income.  There are then adjustments made to this to arrive at Connecticut Taxable Income. For a married couple filing a joint return in Connecticut with AGI of $100,000 their Connecticut income tax rate is 5%.  This rate goes up to 6.99% for couples with earnings over $500,000.

6) By making this election, the amount that is donated is out of your estate.  The federal estate and gift tax exemption in 2023 is $12.92 million per individual.  This amount is indexed to inflation and typically increases slightly ever year.  This means that someone can leave up to this amount and not pay any federal estate tax.  A married couple that uses “portability” can effectively shelter $12.92 million times two or $25.84 million from federal estate tax. With proper planning most people will not be subject to the federal estate tax.  However many people may still be subject to a state estate tax.  In Connecticut the state estate tax exemption in 2023 is on $12.92 million.  The rate starts at 7% and runs up to 12%.  So while most taxpayers will not be subject to the federal estate tax, they still need to be very cognizant of any state estate tax.

7) Qualified Charitable Donations made that exceed your annual RMD will reduce future RMD’s.  As was mentioned earlier the RMD is based on the fair market value of the account from the prior December 31st.  By taking out, via the donation, more than you are required, this will reduce the account value and future RMD’s.

Is this strategy effective for every donation you make?  Not likely.  We advise clients to just use this approach for any material donations you made.  What’s material?  Well, like many other things in life, it depends.  Our approach has been to generally advise clients if they are going to make a donation of $1,000 or more to consider this strategy.  Donations of under $1,000 it’s easier to donate cash, write a check or put it on your credit card.

If you are considering this strategy please, don’t wait until the end of the year.  Paperwork will need to be prepared and processed with the custodian of your assets.  This may take longer than you think.  If you are interested in this approach, kick it off early in the fourth quarter of the year so as to assure you will have all of your paperwork done in good form. People who are eligible for this strategy should take a hard look at it.

Any opinions are those of Thomas F. Scanlon and not necessarily those of RJFS or Raymond James.  All opinions are as of this date and are subject to change without notice. Raymond James does not offer ta or legal advice and services. You should discuss any tax or legal matters with the appropriate professional.