We are all continually looking for ways to save tax dollars. With the 2018 increase in the standard deduction, many individuals switched from itemizing their deductions to the standard deduction. When you take the standard deduction, you do not get a deduction for property and school taxes, medical expenses, or mortgage and home equity loan interest. With the standard deduction, in 2021, you will be able to take up to $600 of charitable contributions if you file using a married filing joint status ($300 for other filing statuses).
Are you over the age of 70 ½? Do you have funds in a Traditional IRA? Do your charitable contributions exceed the $300 or $600 limit? Consider doing a qualified charitable distribution (QCD).
You can tell your IRA custodian to send a contribution directly to the charity of your choice. Instead of making a weekly contribution to your religious organization, have a once-a-quarter or even annual amount sent. Instead of sending a contribution to your school alumni, have a QCD sent directly to the school from your Traditional IRA. A qualified charitable distribution can be sent to any non-profit of your choice. You are allowed to do multiple QCDs a year. The limitation is that your QCDs cannot exceed a total of $100,000 per year.
Why would you want to do a qualified charitable distribution versus simply writing a check to the charitable organization directly? The advantage – if the IRA distribution is a QCD, it is not taxable income to you.
If you send $3,000 directly to a charitable organization from your IRA as a QCD, you do not have to pay taxes on that amount. If your top tax rate is 15% between federal and state, this means a savings of $450 in taxes. If your top tax rate is 27%, you would have a tax saving of $810.
The savings could be even more than just the income tax savings amount. Lowering your adjusted gross income could provide other savings. It could potentially:
- Lower your Medicare premiums
- Reduce the amount of taxable Social Security benefits
- Allow you to qualify for other benefits that are income-based such as NYS enhanced STAR, lower or no EPIC premiums, Medicaid benefits, etc.
- Allow you to fall below or lower your net investment income tax (NIIT), the 3.9% surcharge
- Decrease your capital gains rate from 20% to 15% or from 15% to zero
- Allow you to fall below having to file a tax return
- Increase tax credit amounts or even allow you to qualify for them
If you have an IRA with both deductible and nondeductible contributions, your QCD amount is limited to the portion that would be taxable. You would calculate the taxable portion as normal, and that would be the amount of your QCD.
Your IRA custodian is still required to issue you a Form 1099R for the amount given to the charitable organization. It will be coded generally a Code 7. Your responsibility is to let your tax preparer know that the amount was a qualified charitable distribution. A tax preparer will not know that it was a QCD without making them aware of that fact.
Your tax preparer or you, if you prepare your own tax return, will include the amount in the gross amount received but not in the taxable amount. Next to the taxable amount on Form 1040, you need to make the notation that there was a QCD.
QCDs are only eligible to be made from a Traditional IRA. If your retirement dollars are in a 401(k), a 403(b), or a 457, you cannot do a QCD from these accounts. You will need to first roll the dollars from your employer’s retirement plan to a Traditional IRA. Once the dollars are in the Traditional IRA, you can then do the qualified charitable distribution.
An individual may use their required minimum distribution (RMD) amount as a QCD, up to $100,000. When additional funds are removed from the Traditional IRA, it generally means that future RMDs would be lower since your overall IRA balance would decrease.
If you are below age 70 ½, you are not eligible to do a qualified charitable distribution. You will be eligible for the $300 above-the-line deduction (or $600, if MFJ) on your 2021 tax return. If you exceed the standard deduction amount, you can take additional charitable contributions as part of itemized deductions.
If you are under age 70 ½, your best options may be to consider a charitable remainder trust or a donor-advised fund to get a deduction for larger charitable contributions. This does not allow you to exclude the income distribution from your taxable income, but it can allow you to get an offsetting deduction.
Roth conversions, tax harvesting, and watching for long-term capital gains opportunities are effective ways to decrease your overall taxes. Doing a qualified charitable distribution is another means of reducing the income taxes you will pay.
If you are interested in doing a qualified charitable distribution (QCD), we at Planning with Purpose are ready to help you get that done.
