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The Qualified Charitable Distribution (QCD) rules allow taxpayers to make IRA distributions payable directly to a qualified charity without treating the distribution as taxable income. This law permits up to $100,000 per taxpayer to be contributed directly from an IRA to charity. In addition, the distributions will count towards the IRA owner’s Required Minimum Distribution.
The QCD rules have expired and then extended periodically over the years, and were recently extended again through 2014 with the passage of the Tax Increase Prevention Act of 2014. These rules do expire again after 2014, meaning taxpayers will enter 2015 with the same uncertainty they had throughout the prior year.
Tax rules
In order to be considered a Qualified Charitable Distribution, the following conditions must be met:
The IRA account holder must be age 70½ or older as of the date of the distribution.
Eligible recipients are public charities, excluding donor advised funds and supporting organizations.
The exclusion from income only applies if the distribution otherwise would have been treated as taxable income (which leads to a planning opportunity – see below).
The full payment to the charity would have been allowable for a charitable contribution.
The distribution must be a direct transfer from the IRA trustee to the charity. The IRA owner cannot use the QCD as a way to reimburse themself for gifts already made on their own.
Tax benefits of a qualified charitable distribution
Prior to the QCD rules, a taxpayer could take a distribution from their IRA (which would be included in their Adjusted Gross Income, or AGI), donate the same dollar amount to a charity, and offset the IRA income by claiming an itemized deduction for the donation. In most cases, the two amounts would offset each other and there would be no net impact on the taxpayer’s taxable income. For an IRA distribution treated as a QCD, however, the taxpayer neither reports the income as part of their AGI nor claims a charitable deduction. This treatment may seem to provide the same tax benefit as just donating the cash from the RMD, but it does offer some unique benefits.
Gifts of appreciated stock are often a better alternative
While there are certainly cases where a QCD transaction provides a real tax benefit to the IRA owner, in most cases keeping the RMD and giving appreciated securities to charity will be a better tax strategy.
For example, assume a taxpayer is subject to a $30,000 RMD from their IRA, and is considering giving that directly to charity. They also own stock worth $30,000 that could be donated to charity in lieu of the QCD technique. The first column in the table below shows the tax impact of keeping the RMD and donating the stock to charity. The next four columns show the tax impact of giving the RMD to charity but then selling the stock, assuming different cost basis amounts and therefore different capital gains upon the sale.
|
Donating Stock
|
Donating RMD to Charity (QCD), Selling Stock |
Cost Basis of Stock |
n/a |
$20,000 |
$15,000 |
$10,000 |
$5,000 |
Gain on Stock |
n/a |
$10,000 |
$15,000 |
$20,000 |
$25,000 |
|
|
|
|
|
|
Impact on Taxable Income |
|
|
|
|
|
IRA Distribution |
$30,000 |
$0 |
$0 |
$0 |
$0 |
Capital Gain |
0 |
10,000 |
15,000 |
20,000 |
25,000 |
Charitable Deduction |
(30,000) |
0 |
0 |
0 |
0 |
Phaseout of Itemized Deductions1 |
900 |
300 |
450 |
600 |
750 |
Net Taxable Income Increase |
$900 |
$10,300 |
$15,450 |
$20,600 |
$25,750 |
|
|
|
|
|
|
Combined federal, state ordinary tax |
$384 |
$128 |
$192 |
$256 |
$320 |
3.8% Medicare tax |
- |
380 |
570 |
760 |
950 |
Capital gain tax |
- |
2,302 |
3,453 |
4,604 |
5,755 |
Total tax cost2 |
$384 |
$2,810 |
$4,215 |
$5,620 |
$7,025 |
Tax Advantage of Giving Stock Rather Than the RMD |
n/a |
$2,426 |
$3,831 |
$5,236 |
$6,641 |
As this table shows, the greater the gain on the stock held by the taxpayer, the greater the tax benefit of donating appreciated stock rather than donating the RMD and then selling the stock. The time value of money rules show that this tax benefit would be lessened the longer the gain on the stock is deferred into the future. If the taxpayer plans to hold the stock until death (thereby receiving a basis adjustment and eliminating the gain), then the QCD technique is slightly more attractive. Also, those required to take smaller RMDs from their IRA or in a lower ordinary tax bracket will see less of a difference between these two techniques.
In other words, unless one of scenarios described earlier applies, donating stock is usually a better tax strategy than using the QCD technique.
Tax reporting
Taxpayers doing a QCD transaction should be aware that the custodian of the IRA will still report the distribution from the IRA as a regular withdrawal. The IRA owner will receive a 1099-R reporting the entire distribution from the IRA, including the QCD, which should then be reported on line 15a of their Form 1040. On line 15b, the IRA owner will then enter the difference between the entire distribution amount and the QCD amount. The IRA owner should then write “QCD” next to line 15b identifying that the difference between the line 15a and 15b amounts is tax-free under this exception.
Tim Steffen is Director of Financial Planning for Baird’s Private Wealth Management group, and is a noted expert on the financial and estate planning needs of high-net-worth individuals. Baird is an employee-owned, international wealth management, capital markets, private equity and asset management firm.
Read more articles by Tim Steffen
