In the past, seniors age 70 ½ and above were forced to take required minimum distributions (RMDs) from their IRAS, whether they needed the additional income or not. These RMDs were then treated as income and subject to taxes. The Tax Relief, Unemployment Insurance Reauthorization and Job Creation Act of 2010 extended the deadline for making qualified charitable distributions (QCDs) from IRAs to December 31, 2011. The QCD provision is particularly attractive if seniors do not need their RMD towards living costs and plan to give this money to charity eventually. A QCD saves the individual from having to count the distribution as taxable income.
The Qualified Charitable Distribution Process
Accountholders can instruct their IRA trustees to make a distribution directly to a qualified charity. These QCDs can account for as much as $100,000 of gross income. These distributions can make up all or part of individuals’ RMDs and be directed to single or multiple charities.
For example, an accountholder’s RMD is $20,000. The investor instructs the trustee of his or her IRA to distribute $5,000 to Charity A and $5,000 to Charity B. The investor must then take the remaining $10,000 as a distribution before the end of 2011 to avoid paying a penalty. The IRS considers the $10,000 distribution as part of the accountholder’s taxable income for 2011. However, the accountholder can direct the trustee to distribute $10,000 to each charity and have no taxable income incurred from his or her RMD.
Other Benefits of the QCD Provision
A reduction in their tax burden is not the only benefit provided to seniors. The QCD provision does not require donors to itemize their tax returns. Some states, such as West Virginia, do not allow itemized tax deductions. By making charitable donations directly from their IRAs, taxpayers can avoid additional income and, therefore, state taxes on that income. Those who itemize their tax returns are prevented from deducting more than 50% of their adjusted gross income in charitable donations. However, the QCD is not included in this percentage and allows individuals to exceed the limit.
Many taxpayers’ deduction amounts decrease as their income increases. Required minimum distributions add additional income, often unnecessarily. Large reported incomes may also increase Medicare Part B premiums or have adverse effects on Social Security benefits. By using QCDs, taxpayers can qualify for other tax deductions or savings that their incomes might otherwise prohibit them, multiplying the provision’s benefits.
Restrictions of the QCD
While this provision provides many benefits, it also has limitations. Those who hope to take advantage of a QCD must be 70 ½ or older and have a RMD that would otherwise be considered taxable income. The IRA trustee must make the charitable donation directly to the charity from a traditional or Roth IRA. Donations from previously distributed funds cannot qualify as QCDs. Taxpayers cannot deduct these distributions as charitable contributions on federal income tax returns.
Despite the restrictions, the QCD provision can greatly reduce the taxes owed by wealthy investors. Discuss further benefits with a tax professional or wealth manager to understand how it can affect your finances. Remember to take advantage of this extension before December 31, 2011 to increase your tax savings for the year.