15-Nov-19
Deeper Dive Into Qualified Charitable Distributions
Take-away: As we move toward the end of this calendar year and the obligation to take required minimum distributions, it is also time to keep in mind the opportunity and some of the strange eligibility rules that are associated with qualified charitable distributions, or QCD’s.
Background: A qualified charitable distribution (QCD) is fast becoming the go-to form of charitable giving for retirees who face required minimum distributions (RMDs) from their traditional IRAs. While the direct distribution to a charity from the IRA is not tax deductible, neither is the amount distributed included in the retiree’s taxable income for the year. The result is as if the retiree received a 100% charitable income tax deduction. That result is important because most charitable contributions no longer provide any income tax break for the donor since most donors will no longer itemize their income tax deductions due to the now doubled standard deduction amount ( a change under the 2017 Tax Act.) In addition, with the QCD not causing the RMD to be included in the donor’s reported taxable income for the year, it is possible that: (i) the donor’s subsequent year’s Medicare premium expense will be lower, and (ii) with a lower reported taxable income for the year, the donor may also avoid the net investment income surtax of 3.8%, both of which are tied to the retiree’s reported taxable income for the calendar year.
Qualified Charitable Distribution Rules: Despite the equivalence of a 100% charitable income tax deduction associated with a QCD, there are some strange rules that must be followed.
Age 70 ½: The IRA owner must actually be over age 70 ½ in order to make a qualified charitable distribution (QCD.) It is not just the year in which the donor turns age 70 ½. Example: Sandra turned 70 years old on March 15, 2019. Sandra cannot make any QCDs until September 15, 2019 (when she has actually turned age 70 ½.) Distributions from Sandra’s IRA prior to September 15, 2019 will not be qualified charitable distributions, even when all of the other QCD eligibility rules are satisfied.
$100,000 Limit: A QCD can be used to offset an IRA owner’s required minimum distribution (RMD.) The IRA owner is not restricted by the RMD amount. Any amount, up to $100,000, can be the subject of a QCD. Example: Charlie, age 70 ½, has an RMD of $36,000 in 2019. Charlie can still make QCDs to qualified charities up to $100,000 from his IRA in 2019.
Spouses are Treated Separately: Spouses, if over the age 70 ½, can each avail themselves of the QCD in the same calendar year. Example: Dan and Rosanne, each over the age 70 ½, must take RMDs from their IRAs. Rosanne’s RMD from her IRA is $8,000, while Dan’s RMD is $36,000 from his $1.1 million IRA. Dan and Rosanne each can make a $100,000 from their respective IRAs. However, they cannot make the full $200,000 in QCD’s solely from Dan’s much larger IRA, i.e. no more than $100,000 can be QCD’s from Dan’s IRA for the year. Restated, Rosanne cannot make a larger QCD using the assets held in Dan’s IRA.
Prior Year RMDs: A QCD can also be used to offset a missed RMD from a prior year. Example: Tom inherited an IRA from his mother when he was age 67. Tom has an RMD obligation from that inherited IRA. Tom fails to take his RMD from his inherited IRA. Four years later, now at age 72, Tom takes his missed RMD from the inherited IRA. All RMDs are taxable in the year that they are taken. Tom can offset all of his RMDs (including the late RMD) with QCD’s, up to the annual QCD dollar limit of $100,000.
No ‘Catch-Up’ RMDs: There are no prior-year ‘catch-up’ QCDs, like there are for IRA contributions that can be made up until April 1 of the following calendar year. The hard-and-fast rule for QCD’s is that the QCDs must be made before December 31. The IRA custodian must show the IRA account being debited by the last day of the calendar year in order for the QCD to qualify as such. Some IRA owners will delay taking their first RMD until April 1 of the next calendar year. The IRA owner can still offset that ‘delayed’ RMD with a QCD in the year in which the RMD is actually withdrawn. While the QCD will offset the delayed RMD, the QCD itself will be applied to the actual calendar year when the charitable distributions were made. The IRA owner can make another QCD in that same year to offset the current year’s RMD obligation, so long as the donor stays under the $100,000 annual limitation. Example: Tonia is age 70 ½ this year. She decides to wait until April 1 of 2020 to take her first RMD. On March 15, 2020 Tonia decides that she wants to make a QCD for 2019 and she provides that direction to her IRA custodian. Tonia can make a QCD but it will be treated as satisfying her 2020 RMD obligation, not her 2019 RMD obligation.
Trap – The “First Dollars Out” Rule: The first dollars withdrawn from an IRA when its owner is 70 ½ years old are treated as RMDs. QCD’s can only be used to satisfy RMDs. Consequently, if the initial distribution is taken from an IRA when the IRA owner is 70 ½, those distributions will be treated as RMDs. Thus, there is a timing trap with QCDs. Example: Brad, who is 70 ½, has an RMD obligation for 2019 of $13,000. Brad took a $10,000 distribution from his IRA on February 1, 2019 and he used it to spend a few weeks in sunny Florida. Later in 2019, Brad plans to fulfill an outstanding $5,000 pledge that he has for his alma mater’s capital campaign. Brad uses a QCD to satisfy that campaign pledge. Brad can only use $2,000 of that $5,000 pledge payment as a QCD, since that was the balance of Brad’s ‘unused’ RMD for the year. Consequently, $3,000 of the distributions from Brad’s IRA will be taxable.
No QCDs to Donor-Advised Funds: It is the responsibility of the IRA owner to determine if the charity to which the distribution from the IRA is made is The charity must be an IRC 501(c)(3) qualified charity for the QCD to apply. Neither ‘supporting charitable organizations’ (defined under the Tax Code) nor donor advised funds will qualify as an eligible charity to receive the QCD. If the check is delivered to a non-qualified charity, then the distribution will be taxable to the IRA owner; the charitable gift might still be deductible if the taxpayer itemizes his/her income taxes for the year, but if the taxpayer does not itemize his/her income tax deductions, the gift to the ‘non-qualified’ charity will provide no tax relief to the donor. It is not the obligation of the IRA custodian to monitor the tax exempt status of the distributee of the direct-gift check from the IRA account.
QCD Must be Completed Before End of Calendar Year: IRA custodians that issue checkbooks from which to write the QCD [in lieu of the custodian issuing checks directly from the IRA account on behalf of the IRA owner] can simplify the QCD by enabling the IRA owner to write against the QCD-checking account and mail the check to the charity. IRA custodians can also issue the checks payable to the charity and give the check to the IRA owner for delivery. The only danger with the QCD check delivery is if the QCD is made late in December, and the check does not ‘clear’ until early in January of the following year. Example: Kevin directs his IRA custodian to mail his QCD check to his church on December 29. Due to winter storms, the check is not received, and cashed, by the church until January 2 of the following calendar year. The distribution check from Kevin’s IRA is not a QCD since it was not ‘distributed’ until the following calendar year. Due to this timing issue, it is wise to make QCDs earlier in the calendar year. In addition, it is important to always require a receipt from the charity to document when the QCD was received by the charity. The IRA owner is responsible to inform the IRS about his/her QCD transfers on his/her federal Form 1040 income tax return. The IRA custodian will not use any special code on the Form 1099-R that indicates that the distribution from the IRA was a QCD. To report the QCD, Line 4b on the Form 1040 return would be filled in with a $0.00.
Donor’s Charitable Pledges: Like other charitable gifts, the IRA owner can receive no benefit from the charity when a QCD is made e.g. no t-shirts – no coffee mugs. However, as noted in an earlier example, a QCD can be used to fulfill the IRA owner’s outstanding charitable pledge. The QCD that fulfills an outstanding charitable pledge of the IRA owner will not be treated as a self-dealing prohibited transaction under the normal IRA Regulations.
Traditional IRAs As Source: QCD’s can only be made from a traditional IRA. An inactive SEP IRA and SIMPLE IRA can also be the source of the QCD, but only if no deductible contribution is made to the SEP/SIMPLE in the same year that the QCD is made from that inactive SEP/SIMPLE IRA account. 401(k) account balances cannot be directly used as a source for a QCD, but moving the qualified plan funds to a traditional IRA will permit a QCD to take place. Example: Kristen has access to her employer sponsored qualified plan account, e.g. a 401(k) account. That qualified plan permits Kristen to roll-over all or a portion of her qualified plan account into a traditional IRA. Kristen rolls a portion of her 401(k) account into a traditional IRA; Kristen then makes a QCD from that IRA account.
Qualified Plan Planning: If a qualified plan participant, e.g. 401(k) account owner, intends to offset his RMD from his employer’s qualified plan with a QCD, he cannot do so. Following the first-dollars-out rule for RMDs, the first dollars distributed from the qualified plan to the plan participant will be the participant’s RMD for that calendar year. Presumably, in order to make a QCD from a qualified plan account, the participant will need to take his plan RMD prior to a rollover of an amount to an IRA, from which he could then possibly make a QCD; however, by then, the plan RMD would already have been taken. Example: Bill and Hillary, husband and wife, both worked for the same employer, and both participate in its 401(k) plan. Both Bill and Hillary are over the age 70 ½. Hillary retired a few years ago; she retains her 401(k) retirement account . Bill continues to work and participate in the company’s qualified 401(k) plan. Since Bill is still working, unlike Hillary, he has no RMD obligation with his 401(k) account. Both Bill and Hillary want to make QCDs this year. Hillary has an RMD from her 401(k) plan account. Since a QCD is not available from a 401(k) account, Bill and Hillary must roll some of their 401(k) account funds into their IRAs ‘outside’ the qualified plan. Hillary must take her full RMD from the 401(k) plan before she does the rollover to her traditional IRA, due to the first-dollars-out Hillary cannot take the RMD later from the IRA after the rollover. In contrast, Bill is still working and he has no RMD obligation from the qualified 401(k) plan. Consequently, Bill can rollover a portion of his 401(k) account to his traditional IRA, and then Bill can make a QCD from his IRA.
Roth IRAs: While a QCD can be done with a Roth IRA, it is an unlikely source from which to make a QCD. A QCD is treated as coming only from the pre-tax portion of an IRA. Example: Dean, age 84, has an IRA worth $30,000. Of that amount, $10,000 represents after-tax contributions. If Dean makes a QCD of $20,000 to his church, that QCD would all come from the pre-tax portion of Dean’s IRA. The remaining balance of Dean’s IRA would then consist of tax-free, after-tax, contributions, which Dean could then convert to a Roth IRA without any other tax consequences. Note, however, that if Dean wanted to use his Roth IRA the next calendar year from which to make a QCD, only the taxable earnings on the Roth IRA [earnings in the first 5 years after a Roth IRA conversion] would qualify for the QCD, since those withdrawn Roth earnings would be taxable.
Last Word: Remember the pending SECURE Act. You will recall that the SECURE Act, if enacted as passed by the House, would extend the required beginning date (RBD) to take required minimum distributions (RMD) from age 70 ½ to age 72. There is, however, no corresponding provision in the SECURE Act, at least the version that the House adopted, that would extend the QCD minimum age to 72 years. If the SECURE Act passes in its current form, that would mean that a QCD could be made 18 months prior to when the IRA owner faced RMDs-yet there would be no RMDs to offset with the QCD. This QCD-RMD disparity in ages (70 ½ v 72) could create considerable confusion if the enacted SECURE Act does not get changed to clarify this discrepancy.