A Qualified Charitable Donation (QCD), also known as an IRA charitable rollover, is a tax savings tool for charitably inclined IRA owners. First introduced in the Pension Protection Act of 2006, QCDs were originally permitted for years 2006 and 2007. Since then, however, QCD rules have been in constant limbo. They’ve lapsed, been reinstated (often retroactively), and lapsed again only to be reinstated again. Finally, after eight years of uncertainty, Congress has made QCDs a permanent fixture in the tax law.
A QCD is available to an IRA owner older than 70 ½. If you’re turning 70 ½, be careful, because you can’t simply attain age 70 ½ in the year you do a QCD. You actually have to be at least 70 ½ at the time you do the QCD.
One attractive feature of the QCD is it may satisfy an IRA owner’s Required Minimum Distribution (RMD). QCDs are limited to $100,000 per year, which means you’ll likely be able to do a QCD in excess of your RMD if you wish. The $100,000 limit applies individually, so married couples may contribute up to a combined $200,000. There’s no gift splitting, so each spouse must make a QCD from his or her own IRA.
A QCD must be transferred directly from the IRA custodian to the charity. Checks are fine, as long as the IRA custodian makes the check payable to the charity. It’s even alright for you to receive the check (as long as it’s not made out to you) and deliver it to the charity.
It’s also important to note that QCDs may only be done from an IRA and are not allowed from other types of retirement accounts, such as the Thrift Savings Plan and 401ks.
For those who normally give to charity, another key benefit of the QCD is that the amount transferred from the IRA to the charity is not included as income (subject to the $100,000 annual limit) when calculating adjusted gross income (AGI). This is beneficial, because bad things happen as AGI increases and reaches certain levels. For example, at certain AGI thresholds, taxpayers experience loss of personal exemptions and phaseout of itemized deductions. By maintaining a lower AGI, a QCD may also help you avoid the alternative minimum tax, the 3.8 percent Medicare surtax on investment income, and higher Medicare Part B and Part D premiums.
Additionally, the tax rate you pay on capital gains is ultimately determined by your income. For example, if you’re in the 25 percent, 28 percent, 33 percent or 35 percent tax bracket, your long-term capital gains tax rate is 15%. If you’re in the 39.6 percent bracket, the long-term capital gains tax rate increases to 20 percent. But for those in the 10 percent and 15 percent brackets, the long-term capital gains tax rate is 0 percent.
Medical expenses tend to increase with age. Fortunately, the IRS gives us a small tax break by allowing us to deduct qualified medical expenses as an itemized deduction. Here again, AGI plays a role and using a QCD to keep your AGI lower will potentially allow you to deduct more of your medical expenses.
If you itemize your deductions, you get to deduct your charitable contributions, up to a cap equal to 50 percent of your AGI (20 percent and 30 percent limits apply in some cases). But what about those who don’t have enough deductions to itemize? Because QCDs are excluded from income, QCDs are a great way for folks claiming a standard deduction to get a tax break too.
Another neat feature of a QCD is that they are presumed to come from the pre-tax portion of the IRA account. In normal circumstances, the “pro-rata” rule dictates an IRA distribution will consist of pre-tax and post-tax money (assuming the IRA holds post-tax money). This means you can isolate the basis (post-tax contributions) in your IRA by donating the pre-tax money to charity via the QCD and then convert the remaining basis to a Roth IRA tax free. Or at very least, you can reduce the pre-tax money so more of a Roth conversion comes from after-tax funds, thereby reducing the taxable conversion income.
If you’re charitably inclined, the QCD may be an excellent gifting strategy for you.