Charitable distributions — from your Individual Retirement Account (IRA) directly to your favorite charity — can save you income taxes. Of course, you can deduct charitable donations anyway, so you might wonder how this exotic (okay — not really that exotic) technique is even better for many taxpayers.
First: what is a “qualified charitable distribution?”
Qualified charitable distributions — almost everyone uses the acronym QCD — are more potent than many other charitable gifts. But what makes them “qualified”?
A qualified charitable deduction is one made directly from an IRA to a 501(c)(3) organization. You can check whether your favorite charity is recognized as a 501(c)(3) organization online. There are thousands, but the Internal Revenue Service (IRS) maintains a handy list, searchable by location. Check Tucson, Arizona, as one example: it turns out that there are over 6,000 qualifying entities located in our fair city.
The search engine can be a bit overwhelming — and even misleading. Take, for example, one of our favorite charitable organizations — Mission Garden. Plug its name into the IRS search engine and you’ll come up with three entities but not our Mission Garden. They all sound worthy, but they are not here. You have to know that the correct name of the charitable organization operating Mission Garden is The Friends of Tucson’s Birthplace. Still not seeing it? You have to know to drop the apostrophe to find the details.
But that’s not the primary point. If you arrange for your IRA custodian to send a charitable distribution directly to The Friends of Tucson’s Birthplace (even if the check says “Mission Garden”), you might have made a qualified charitable distribution.
What else do you have to do to make your distribution “qualified”? It’s pretty simple, actually: you have to be age 70 1/2 or older, and the gift has to come from your IRA.
So what’s better about doing it this way?
If you wanted to make a gift to your favorite charity, and to use your IRA to fund that gift, you could do it the old-fashioned, two-step way. You could ask for a distribution from your IRA and then, once you received the payout, make a gift of the same amount.
But if you do that, you’ll have to report the income from your IRA before you take the deduction. And your deduction might not be worth the full amount of your IRA distribution.
Why not? There are a couple of reasons. First, you might not get any value out of your charitable gifts. That may seem unlikely, but the reality is that about 90% of taxpayers take the (currently quite substantial) standard deduction. Of course, that’s partly because of the big increase in the standard deduction back in 2018. But even before that change about 70% of taxpayers took the standard deduction.
Even if you make a really large charitable gift, you might not get full value. That’s because the portion of your gift that raises you from below the standard deduction to that number is effectively “lost” — you would have gotten that “deduction” even without making the gift.
And then there’s the limitation on really, really large gifts. You can’t deduct more than 50%-60% (the limits vary for different taxpayers) of your Adjusted Gross Income (AGI). Of course, you can “roll over” unused deductions for future years, but they won’t help you in the current year — and they might never help you if you don’t itemize in future years.
Enter the qualified charitable distributions
So keeping the charitable distribution out of your income calculation altogether is clearly better, faster and more effective for many — probably most — taxpayers. And that’s just for people who decide to make the qualified charitable distribution from their IRAs when they don’t have to take any distributions.
BONUS: the amount of your IRA distribution won’t get added to your Adjusted Gross Income, and it won’t affect your Income Related Monthly Adjustment Amount (IRMAA), perhaps helping to hold down your Medicare premium calculations. Of course, there’s a two-year delay in the IRMAA calculation, so you might not see any benefit this year or even next year — but the dollar amounts can be real, and the benefits substantial.
Required minimum distributions (RMDs) change the calculation
If you have an IRA and you are age 73 or older, you probably have a required minimum distribution on your tax horizon. If you turned 73 this year, for example, you will need to take out about 3.8% of your IRA — and report it on your income tax return. So you’re going to face taxable income of (to be technical) 1/26.5 of your IRA’s value as of last December 31.
[As an aside, this is not quite correct. If you turned 73 this year, you can delay your distribution until early next year. But then you have the 2025 AND the 2026 distributions to deal with next year. So it just makes your tax situation worse, though it delays the pain.]
So instead consider a qualified charitable distribution. You direct just the RMD — the minimum amount you have to take out — to a qualifying charity or charities. Now you get a 1099 from your IRA custodian, BUT you get to deduct the full amount of your qualified charitable distribution from the income itself. So you don’t pay income taxes on that amount and don’t have to do anything to maximize the charitable gift benefit.
Want to hear a discussion of these issues?
We’ve talked about this qualified charitable distribution issue before. In our April 4, 2021, Elder Law Issues podcast, we discussed the rules as they then existed. Not much has changed, though it is now clear that you can make QCDs even before you are subject to minimum distribution rules. The age at which RMDs kick in has gone up since that podcast date, and some of the calculations have changed. But the rules are pretty much the same.
One key rule that has not changed: you can ONLY do this with your IRA. Do you have a 401(k), a 403(b), or a different kind of retirement account? Sorry, you’re out of luck. Of course, you might be able to convert your retirement account into an IRA and then apply the QCD rules, but that’s a discussion for another day, and one you probably want to have with your CPA.