Under the new tax law (Tax Cuts and Jobs Act signed by the President on December 22, 2017), fewer individuals will itemize their deductions on their tax returns. While the increase in the standard deduction may be a boon for some, it also poses a challenge for charities. In the past, individuals who itemized their deductions were allowed to take charitable deductions. Now, if individuals take the standard deduction, they will not take a separate charitable deduction and therefore, may not be inclined to make charitable contributions since it will not benefit them tax-wise.
Individuals who are required to take minimum distributions from IRAs (RMDs) after age 70 ½, and who are charitably inclined have a way of making those contributions and receiving a tax benefit. An individual can make charitable contributions from their IRA’s directly to the charity of their choice. They can direct that some or all of their RMD be sent directly to the charity instead receiving the income distribution. These are known as qualified charitable distributions (QCDs).
The Qualified Charitable Distribution is not taxable to the IRA owner and is exempt from taxation to the charity. This allows the IRA owner to save income taxes by not having to include the amount of the Qualified Charitable Distribution in their taxable income as they ordinarily would if it were part of their required minimum distribution. As an example, Mary is required to withdraw $54,000 from her IRA this year. This distribution will push her from the 22% to the 24% income tax bracket, potentially costing her nearly $13,000 in income tax. Instead, she could tell the trustee of her IRA to send a contribution to her favorite charity (MPT) and owe no income tax on the amount transferred. If she sent $5,000 to the charity it would save her nearly $1,200 in income tax.
Keeping taxable income down in the current year might also result in lower Medicare premiums for Mary because the Medicare premiums are based upon the modified adjusted gross income (MAGI) she received in the immediate prior tax year. Qualified Charitable Distribution amounts are not included in the charitable deduction limitations. Cash gifts are generally only deductible up to 60% of the donor’s adjusted gross income, but the amount given through Qualified Charitable Distribution is not counted in that limit. Donors may give up to $100,000 tax-free annually from their IRA using Qualified Charitable Distribution. Giving a contribution from the IRA may also reduce the donor’s IRA balance resulting in lower RMDs in later years.
Donors should be cautioned that the Qualified Charitable Distribution must come directly from the IRA trustee and can pass only to public charities that are qualified by the IRS. Qualified Charitable Distribution cannot be given to donor advised funds or a private foundation. Also, a Qualified Charitable Distribution cannot be used to fund a charitable remainder trust or charitable gift annuities.
Another important rule is that the Qualified Charitable Distribution must be made before any RMD is taken. Once an IRA is subject to RMDs, the first dollars withdrawn during the year are deemed to count toward satisfying the RMD. Since the Qualified Charitable Distribution counts towards satisfying the RMD, thereby excluding that income from taxation, it is important to make those distributions