Qualified Charitable Distributions

by Tom Yamachika, President, Tax Foundation Hawaii

I’m sometimes asked, “What’s the biggest break that today’s tax code gives us?”

There are many ways to measure big breaks, of course, but how about this one:  Qualified Charitable Distributions.

This benefit is mainly for those of us who are older and who have put a fair amount of retirement savings into a tax-deferred Individual Retirement Account, or IRA.  The reason it’s called tax-deferred is that although you earned the money that went into the account, you didn’t pay tax when it went in.  So, the theory is that you pay the tax when the money comes out, which hopefully is at a lower rate than was in effect at the time it went in.

Let’s also say that you want to contribute some money to a 501(c)(3) nonprofit, such as the Tax Foundation of Hawaii (shameless plug there).  What most people would have to do is take the money out of the IRA, giving you taxable income, and donate the money to the charity, giving you a deduction for the amount you contributed.  But, these days, the offsetting deduction might not be available.  For example, given the size of the federal and state standard deductions, even a good-sized charitable deduction might not make a difference.  Or, the Pease limit, which is still alive in the Hawaii tax code, eats away at your itemized deductions once your income goes above a certain level.

If, however, you are at least 70-1/2 years old at the end of the tax year, you can do something else.  You tell your IRA trustee to make the donation instead.  The money comes out and gets sent to the charity.  But it doesn’t count as taxable income at all (within limits).

That doesn’t mean you can forget about it when it comes time to file your tax return.  The amount of the distribution still gets reported to you on Form 1099-R.  The amount of the distribution goes on line 4a, where the form asks you about whether you received any IRA distributions.  But you can then exclude it from line 4b, where the form asks you about the taxable amount.  The IRS instructions then say to put the letters “QCD” next to the small number in line 4b to let them know that you took a qualified charitable distribution.

Furthermore, if you’re age 73, you can’t just let your money stay in a traditional IRA.  There is an amount called an RMD, or “required minimum distribution.”  If you don’t take your RMD out of your IRA, penalties kick in.  The good news is that a QCD is a distribution from your IRA and counts toward your RMD requirement.  So, if you have to take some money out of your IRA anyway, and you want to give some of it to charity anyway, then bingo!  A QCD combines the two steps.

Of course, like everything else, there are limits imposed.  You can do QCDs up to $100,000 per year.  If your personal wealth hasn’t yet gone from rich to ridiculous, however, that limit probably isn’t a cause for great concern.  But even if it is, the limit is doubled – to $200,000 – on a joint return if both spouses are over age 70-1/2 and both have IRAs.

And, don’t forget to get a receipt from the charity.  Charities receiving contributions are supposed to give a receipt stating the date and amount of the contribution, and whether the donor got anything of value in return for it.

Finally, and especially if you are considering making a sizable contribution, take a couple of minutes to chat with your tax professional to make sure your strategy works.  This article only talks about general principles, and our actual tax code is far too complex to be summarized in an article of this length.