Qualified Charitable Distributions – A Powerful Tool for Those Who Qualify

In today’s world of higher standard deductions and fewer itemized deductions, the Qualified Charitable Distribution (“QCD”) is a powerful tool that should be considered. For eligible taxpayers who have charitable obligations to meet, this is a winning strategy with practically no negative consequences. Basically, a QCD allows the taxpayer to get a deduction “right off the top”, by never reporting funds in their taxable income that are used to fund the charitable contribution.

What is a QCD?

Here, the taxpayer directs their IRA (individual retirement account) custodian to send IRA funds directly to charity. If the taxpayer qualifies, the IRA funds that went to charity are not deductible, but the IRA proceeds are not included in the taxpayer’s income. The result is that the taxpayer gets a tax deduction “off the top” by never including the retirement distribution in income in the first place.

Required Minimum Distributions (“RMD”)

Before the QCD rules are explained, first the taxpayer should understand the RMD rules. This is a basic explanation, as there are a host of special rules and exceptions that could apply.

Under the Internal Revenue Code, a taxpayer is subject to taxable income plus penalties when funds are withdrawn from retirement accounts before age 59-1/2. Once the taxpayer reaches age 59-1/2, they can generally withdraw from their retirement account and face income taxes but not penalties.

However, once the taxpayer reaches a certain age, they cannot put off retirement withdrawals any further. Traditionally, this age has been the year the taxpayer attains age 70-1/2. As of the year the taxpayer reaches this age, they are subject to the RMD rules, by which a formula mandates a minimum amount of retirement distributions to take that year. Penalties can also apply if the taxpayer does not withdraw enough when subject to the RMD rules. The 2019 SECURE Act is gradually moving the age forward when the RMDs begin, eventually up to age 75. Currently, the RMD rules start at age 73.

For taxpayers who are married-filing-jointly, the RMD rules are determined separately, with each of the couple having their own retirement accounts and age requirements.

What are the core requirements of a QCD?

1. The taxpayer directs their IRA custodian to send IRA funds directly to charity. The taxpayer must not touch the funds, even momentarily. Only traditional and Roth IRA accounts are eligible – not qualified retirement plans (like 401(k) plans), and not other personal retirement account plans such as SEPs or SIMPLEs.

2. The taxpayer must have attained age 70-1/2 on the date of the transfer (not in the year of the transfer). The QCD rules were put into place when RMDs started at age 70-1/2. The 2019 SECURE Act is moving the RMD beginning age, but the QCD age of 70-1/2 has not changed.

3. The maximum transfer amount is $100,000 annually. This cap is applied per-taxpayer, not per-return or per-account. However, the maximum is indexed for inflation in increments of $5,000, and the cap becomes $105,000 for 2024. Since the maximum is per-taxpayer, a married-filing-jointly taxpayer can have QCDs of as much as $210,000. Of course, in this case, each of the married taxpayers must qualify and must have sufficient retirement funds in their own name to use to fund QCDs. The husband cannot use his IRA to fund the wife’s QCD, for example.

4. The funds must go directly to a qualified public charity. Private foundations or donor advised funds are not qualified. QCD treatment is available only when the charitable contribution would have been entirely deductible. Thus, if the taxpayer receives any benefit from the charity that would normally reduce the deduction, then QCD treatment is not available.

a. Beginning in 2023, a one-time transfer of up to $50,000 (indexed for inflation after 2023) can be done to certain split-interest entities, such as charitable remainder trusts (“CRTs”) or charitable gift annuities. Other requirements exist, including that the split-interest trust must be exclusively funded by this QCD. This requirement means that the one-time transfer to a CRT is of limited value, since $50,000 is really too low of a contribution to economically justify the establishment and administration of a CRT. This rule practically only applies to gift annuities.

5. The 2019 SECURE Act removed the age restriction on making deductible IRA contributions. But the law also states that if a taxpayer makes deductible IRA contributions after age 70-1/2, the amount of QCD that is excluded from income is limited. However, where the exclusion from income is lost, that part of the charitable tax deduction is restored. The point of this rule is to prevent a taxpayer from getting an IRA contribution deduction, and then redirecting those funds to charity via a QCD and excluding the withdrawal from income.

a. Example. A 74-year-old taxpayer has never made a QCD, but wishes to do so in 2024. He has made $28,500 in deductible IRA contributions after age 70-1/2.

b. In 2024, he transfers $25,000 from his IRA to charity. None of it qualifies as a QCD because it is less than the post-70-1/2 deductible contributions of $28,500. All of the IRA withdrawal is taxable income and the $25,000 is a deductible charitable contribution.

c. In 2025, he transfers another $20,000 from his IRA to charity. He still has $3,500 of post-70-1/2 contributions that have not reduced prior QCDs. Thus $3,500 of the transfer does not qualify as a QCD, but the other $16,500 is a QCD. The $3,500 is a taxable IRA distribution and a deductible charitable contribution.

d. In 2026, he transfers another $30,000 from his IRA to charity. The entire $30,000 can qualify as a QCD and can be excluded from income.

Advantages of QCDs

1. QCDs satisfy that portion of the taxpayer’s RMD requirement for that year. For example, a taxpayer has a $56,000 RMD requirement for the year. She directs her IRA custodian to send $20,000 of her IRA to her church. She now has a RMD requirement for the balance of $36,000 for the year.

2. QCDs bypass the 60% of adjusted gross income (“AGI”) limit on charitable contribution deductions.

3. With higher standard deductions, more and more taxpayers find that there are no tax savings for their charitable spending. QCDs can bypass that limitation.

4. QCDs are paid directly to charity and thus do not increase AGI. Many negative things happen when AGI increases, including –

a. Medical deductions are lost due to higher AGI limitations,

b. More social security collections are subject to income tax,

c. More passive loss limitations are imposed,

d. More income is subject to the 3.8% tax on net investment income,

e. Medicare insurance premiums (IRMA) increase, and

f. More credits are phased out.

5. For a taxpayer who has a traditional IRA with tax basis from nondeductible contributions, a withdrawal distribution from the IRA is treated as coming partly from the basis (non-taxable) and the rest from the taxable part. However, a QCD in this situation is treated as coming first from the taxable part of the IRA.

Some planning ideas

1. Since QCDs reduce the RMD requirement for that year, the taxpayer should budget how much of the IRA they will send to charity that year before any RMDs are taken.

a. Example. A taxpayer has a $45,000 RMD requirement for the year. They have a $20,000 charitable commitment to meet. Funding the charitable commitment from the IRA means that only $25,000 of RMD requirement remains. However, if he had already taken the entire $45,000 RMD from the IRA, they must decide whether to take another $20,000 from the IRA for charity or make the charitable payment from their after-tax funds.

2. For the taxpayer who wants to do a QCD but lacks IRA funds, consider rolling some retirement funds from another type of account to an IRA first.

3. QCD funds must be taxable retirement distributions. This means that Roth IRA funds are not eligible unless the taxpayer does not qualify for tax-free Roth distributions for some reason.

4. Generally speaking, Roth IRA funds are not a good candidate for QCDs, since these funds are already tax-free and exempt from the RMD rules (during the life of the account creator). For inherited IRAs, the RMD rules apply but the account is still tax-free, and thus still not a good source of QCDs. Also, those inheriting IRA funds are subject to the RMD rules despite not being age 70-1/2, and the 70-1/2 requirement remains. Thus IRA beneficiaries may not even be eligible for QCDs.

Qualified charitable distributions are a powerful part of the tax plan for those taxpayers who qualify. Taxpayers should plan their use of this tool intentionally and carefully for maximum benefit.

Please do not take any action based only on this information. Instead, consult a competent tax professional who is knowledgeable about your specific situation.