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George F. Bearup, J.D. Senior Legal Trust Advisor

July 17, 2023

QCD Quirks

Take-Away: It is probably a good time to revisit the qualified charitable distribution rules, now that there is a new ‘option’ to transfer a limited amount via a QCD to either a charitable remainder trust (CRT) or a charitable gift annuity (CGA.)

Background: Qualified charitable distributions (QCDs) from IRAs are a popular form of charitable giving these days, particularly for anyone who is subject to a required minimum distribution (RMD) from their traditional IRA. The SECURE Act 2.0 brought even more attention to QCDs, but with questionable utility,  with the new provision that permits up to $50,000 to be part of a QCD to fund either a charitable remainder trust (CRT) or a charitable gift annuity (CGA.) [IRC 514(c)(5).] However, like much of what Congress comes up with in the tax laws these days, there is a layer complexity with QCDs, and thus a couple traps to watch out for, when making a QCD.

QCD Basics: The important rules to remember when a QCD is made include the following:

  1. The IRA owner must be age 70 1/2 prior to making the QCD. [IRC 408(d)(8)(B)(ii).] Not just that the age attained in the year in which the QCD is made. The donor must actually be that age when the QCD is made.
  2. A maximum of $100,000 can be used to fund a. QCD in a calendar year. A married couple, each over age 70 1/2, could make maximum $100,000 QCDs from their respective IRAs. This maximum amount is not subject to indexing.
  3. QCDs are made directly from the traditional IRA to the recipient charity. Conceivably the donor could deliver the check to the charity, but the check must be made out to the charity by the IRA custodian.
  4. Only traditional IRAs are eligible as the source of the QCD, not qualified plan accounts, like 401(k) accounts, nor 403(b) annuities. Some Roth IRAs might be a source of funding a QCD. (More on this limited opportunity below.)
  5. A SEP IRA or SIMPLE IRA cannot be used as the source of a QCD if there are ongoing contributions to that SEP IRA or SIMPLE IRA. In other words, if deductible contributions were made during the year to a SEP IRA or SIMPLE IRA, a QCD cannot be made from that same SEP/SIMPLE IRA. If no deductible contributions were made to the SEP/SIMPLE IRA in a year, then these IRAs can be the source of QCDs for that same year.
  6. The QCD from the IRA must be otherwise fully taxable income. [IRC 408(d)(8)(B).] This requirement then poses a problem if the traditional IRA also holds after-tax contributions which are not, technically, fully taxable income. [A limited solutions exists- see the Example, below.]
  7. Only certain charities can receive a QCD. Those charities that are described in IRC 170(b)(1)(A) are eligible. Excluded  are supporting organizations [IRC 509(a)(3)] and donor advised funds (DAFs.)  A distribution from an IRA to a DAF will result in taxable income to the donor. Grant making private foundation organizations are also excluded from receiving QCDs, but a private operating foundation, like a library or a museum, can be an eligible QCD recipient.
  8. If a CRT or a CGA is funded using an IRA (up to $50,000 ) it must result from a one-time only transfer and the CRT/CGA must be “funded exclusively by qualified charitable distributions.” This means that an existing CRT cannot be used to receive a QCD. Nor can other assets be added to a CRT that was initially funded with a QCD, the result being that few, if any, CRTs will be set-up to receive a $50,000 QCD due to the cost in setting up and maintaining a CRT.
  9. All-encompassing is the requirement that in order to be a QCD, the charitable gift must have met all of the requirements to qualify for charitable income tax deduction under IRC 170, including the substantiation requirements and the contemporaneous written acknowledgement from the recipient charity. [IRS Notice 2007-7 (Q&A 39.)]

QCD Benefit: The benefit of using a QCD is that the distribution to the charity is applied toward the donor’s RMD obligation for the year. Therefore, the QCD amount is not included in the donor’s taxable income for the year, which might keep the donor in a lower marginal income tax bracket, maintain the donor’s eligibility to some tax deductions or credits which are tied to reported adjusted gross income, and also possibly lower the donor’s Medicare premium obligation. However, the donor of the QCD is not entitled to deduct the amount paid to the charity. As an itemized charitable deduction. This is important when you consider that in 2020 taxpayers claimed itemized deductions on only 9.5% of all tax returns, which means that a charitable income tax deduction does not produce a tax benefit in over 90% of the tax returns that use the standard deduction.

Special Rule: Fortunately, with regard to the last requirement (#6 above) there is a special rule that reduces some of that risk when a traditional IRA holds some nondeducted contributions. That rule provides that charitable distributions from traditional IRAs that hold nondeducted (after-tax) contributions are deemed to come first from the taxable portion of the IRA, thus leaving the maximum amount of tax-free dollars in the IRA after the QCD is made. [IRC 408(d)(8)(D).]

  • Example: Archie’s traditional IRA has a balance of $100,000, which consists of $80,000 tax deductible contributions and $20,000 of nondeductible (after-tax) contributions. If there is a direct distribution to qualified charity from Archie’s IRA, then the distribution from Archie’s IRA is deemed to come first from its taxable portion. Consequently, if the IRA custodian makes an $80,000 QCD to Archie’s favorite charity, no portion of the $80,000 will be included in Archie’s taxable income and that amount will be applied towards Archie’s RMD for that calendar year. The remaining $20,000 in Archie’s IRA will be treated as consisting entirely nondeductible (after-tax) contributions.

Quirks: These technical QCD rules, and the new provisions to use a QCD to fund a CRT or CGA, can create some quirks that can lead to some traps for the unwary.

  • Roth IRAs: Generally, distributions from Roth IRAs are tax-free, and thus ineligible for QCD treatment. However, if the Roth IRA owner has not had the Roth IRA in existence for at least 5 years prior to the direct distribution to the charity then, in that case, there could be taxable investment income in the Roth IRA that would be eligible for QCD treatment. It is probably wise to consider that a Roth IRA is not a good source with which to make a QCD.
  • Still Working Contributions: The still working IRA owner can continue to deduct contributions to his/her IRA after attaining age 70 1/2. However, a direct distribution to a charity, or to a CRT, or to CGA, will not be excluded from the donor’s taxable income until the full amount of those after-age-70 1/2- tax deducted contributions have been fully ‘recovered’ through charitable income tax deductions. Restated, if deducted post-age 70 1/2 IRA contributions have been made, those contributions must be ‘recovered’ and reported in the donor’s income before future QCDs can be made from the donor’s traditional IRA. The earlier contribution deductions must be recovered and reported in income before the QCD is effective to be applied towards the QCD and excluded from reported income.
  • If either nondeducted contributions , or perhaps post-age 70 1/2 deducted contributions, are distributed from an IRA to a charity, that portion does not qualify as a QCD.  For nondeducted IRA contributions, the donor is deemed to have received that amount free from income tax and can claim an itemized charitable income tax deduction for a charitable gift of that part of the payment. For donors who deducted contributions to an IRA after age 70 1/2, the charitable distribution is treated as taxable income to the donor, and the donor can claim an offsetting itemized charitable income tax deduction for the charitable gift for that part of the distribution. Of course, if the donor is claiming the standard income tax deduction, then that charitable income tax deduction may be of no use. –Example: Edith has an IRA that holds $100,000 of assets, of which $6,000 consisted of contributions that Edith made and deducted while she was working after age 70 1/2. If $10,000 is transferred from Edith’s IRA directly to a charity, the first $6,000 will be taxable income to Edith, and only the remaining $4,000 will qualify as a QCD that is excluded from Edith’s taxable income. Edith can claim an itemized charitable income tax deduction of $6,000 under the customary rules that apply to charitable gifts under IRC 170.
  •  Split-Interest QCDs: As a generalization, an IRA owner can only use the QCD exclusion for a gift to a split-interest entity in one taxable year during their lifetime.[IRC 408(d)(8)(F)(i)(1).] In that year, the donor’s maximum QCD exclusion for the gift to the split-interest entity is $50,000. The CGA or CRT must be funded exclusively with otherwise taxable QCDs of the IRA donor. The CGA must commence fixed payments of at least 5% no later than one year from the date of the CGA/CRT funding. Also, while most CGAs can be for two lives, under this QCD exception, the two lives must be spouses.
  • Example: Mike has an IRA with a balance of $50,000 at Trustco, and he also has an IRA with Bankco that holds another $50,000. Mike made nondeductible contributions of $20,000 to his Trustco IRA. Mike’s Bankco IRA holds all deductible contributions. Mike transfers the entire $50,000 balance of the Trustco IRA to his favorite charity in exchange for a CGA. Fortunately, under a special rule in the Tax Code [IRC 408(d)(8)(D)] all IRAs are treated as a single IRA. Consequently, the entire $50,000 distribution from Mike’s Trustco IRA qualifies as a QCD. The $50,000 held in the Bankco IRA is now deemed to hold the $20,000 of nondeductible contributions.
    • Example: Gloria, over age 70 1/2, wishes to take her a portion of her traditional $75,000 IRA and transfer $50,000 of that balance in exchange for a CGA that is sponsored by her favorite charity. It is possible that all of the assets held in the CGA (including the portion that does not qualify for the charitable remainder interest meets the definition of “funded exclusively by qualified charitable distributions.” But what if Gloria had as some of her IRA  held in nondeductible contributions, or Gloria had made a post-age 70 1/2 deductible contribution to her IRA. The CGA must be funded exclusively with QCDs for the IRA distribution to be excluded from Gloria’s income. It is also possible that the IRS will take a different position when a split-interest entity receives post-age 70 1/2 distributions, if the distribution would include amounts that Gloria deducted as a contribution after age 70 1/2. No one knows how the IRS will treat a QCD to a split-interest CRT or CGA when: (i) some of the contribution is allocated to the annuity the donor receives; (ii) the QCD consists in part of after-tax contributions; or (iii) the QCD from the IRA consists of post-age 70 1/2 deductible contributions to the IRA.
  • Doubling Up?: Because an eligible split-interest entity can last for the joint lives of a married couple, it might be possible for each spouse to separately contribute to that CGA/CRT from their respective IRAs. Such split-interest entity would then be funded exclusively with QCDs made by the beneficiaries of that CGA or CRT. A $50,000 contribution probably does not warrant the expense of administrative grief of funding a CRT, but perhaps a ‘doubling up’ of $100,000 to a CRT might be warrant the additional start-up expense.
    • Example: Archie and Edith, a married couple each age 75, decide to take $50,000 from their respective IRAs and fund a $100,000 CGA using QCDs. They approach the local hospital that uses CGAs as part of his fundraising activities. Archie and Edith are given by the hospital a CGA that is consistent with the form used by the American Council on Gift Annuities, regularly used by the hospital. Archie and Edith’s QCDs fail because the standard CGA form contains a standard provision that permits an assignment of the annuitant’s interest to the charity. That assignment provision  is prohibited under the current spit-interest option under the QCD rules.

Conclusion: QCDs are a great way for seniors to support their favorite charities. With the new split-interest rules, a CGA is now a good option for married seniors who want to receive a steady and reliable income stream for the rest of their lives while still support their favorite charity. Unfortunately the QCD rules are deceptively simple; rather they are both technical and complicated. Consequently, it is easy to make a mistake, possibly losing the tax advantages that QCDs are intended to achieve, and in some cases leaving the donor with taxable income, and no charitable income tax deduction.