Qualified Charitable Distribution Traps

Take-Away: While a qualified charitable distribution (QCD) from an IRA seems pretty straightforward, there can be a lot of confusion that leads to mistakes, and thus taxable income when a QCD goes awry.

Background: As the end of 2022 fast approaches, along with the December 31 deadline in which to take a required minimum distribution (RMD) from an IRA, older individuals once again start to think about using the ever-popular qualified charitable distribution (QCD) to fulfill their philanthropic wishes while meeting their RMD obligation for the year. A QCD is a great way to keep taxes low and also help charities. The QCD, up to $100,000 a year, counts towards the IRA owner’s RMD for the year, and yet that distribution is excluded from the owner’s taxable income. [Note, though, that there can be no claiming a charitable income tax deduction if the QCD is used.) With those benefits in mind, it is important to realize that  mistakes are still made with QCDs, meaning that there are several ‘traps’ along the way. Some of those mistakes or ‘traps’ are summarized below.

1. Only After Age 70 ½: It is not ‘the year in which you turn 70 ½,’ nor is it ‘six month after attaining that age 70 ½’ that is the condition. Rather, it  is when the IRA owner actually is age 70 ½ that a QCD can be made.

Example:  Wendy turns age 70 ½ on December 30, 2022. Wendy  will have only one day in 2022 in which to make and complete her QCD. [One day because December 31 is on a Saturday this year.] This age 70 ½ rule confuses a lot of folks because the required beginning date (RBD) was increased in 2020 from age 70 ½ to age 72, so they sometimes think that they cannot make a QCD because they have no RMD- not so.

2. Only from Traditional IRAs: While this rule seems simple on its face, it is misleading. If the IRA that is owned is part of a SEP-IRA or SIMPLE-IRA, those are employer sponsored qualified plans, and as such they are not “IRAs” from which a QCD can be made.[Notice 2007-7, A-36.] Normally a QCD cannot be made from a Roth IRA because of the requirement that a QCD must be made ‘only from amounts that would otherwise be includible in the owner’s gross income.’ Usually distributions from a Roth IRA are tax-free. Obviously, too, no QCD can be made from a qualified plan account, like a 401(k) account; a QCD can only be made from an IRA. And for the dollar limitation purpose, all IRAs owned by the same individual are aggregated as one IRA. A QCD can also be made from an inherited IRA, but the $100,000 annual QCD limit applies to all of the owner’s IRAs, not each separate IRA, traditional or inherited.
3. Only by the IRA Owner: Each individual over the age of 70 ½ is eligible to make a QCD. Accordingly, if both spouses own IRAs, they each can make a QCD from their respective IRA. However, unlike other gifts which can be split between spouses, there is no gift- splitting by spouses when it comes to making a QCD.

Example: Fred and Ethel are each over the age of 70 ½. Each of Fred and Ethel own a traditional IRA. Ethel wants to give to their church $200,000 as part of the church’s capital campaign. Each of Fred and Ethel can make a QCD up to $100,000 in a year to the church. While Ethel is prepared to make a $100,000 QCD, Fred is unwilling to make a charitable gift using his IRA. Ethel cannot make a $200,000 from her IRA and agree with Fred to ‘split-gifts’ for the calendar year. The most that Ethel can make as a QCD from her IRA is $100,000. Ethel cannot ‘borrow’ Fred’s unused $100,000 QCD limit. [She always said Fred was ‘cheap!’]

4. Only Some Charities Will Qualify: Much to the dismay of many philanthropically inclined individuals, a QCD cannot be made to a donor advised fund. While the QCD rules [IRC 408(d)(8)] refer to QCDs to a ‘public charity,’ donor advised funds are expressly excluded from being eligible to receive a QCD. The same goes for ‘supporting organizations’, i.e. public charities that exist solely to support another charity, and for some private foundations.
5. Only One Form of Delivery: A QCD must be paid directly from the IRA, by its custodian, to the charity. It is possible to make a QCD with a ‘checkbook IRA’ where the check is written and made payable directly to the charity. But if a check is written against the IRA made payable to the IRA owner, who in turn endorses that check over to the charity, that form of delivery will not be a qualified charitable distribution.
6. Only if Other Charitable Giving Restrictions are Followed: In order for a contribution to a charity to qualify as a tax deductible charitable contribution,  the can be no return of benefit’ to the donor. Thus, if the donor of a QCD receives something in exchange from the charity for the QCD, the QCD will be disqualified. This is a bit of a ‘slippery slope’ since the IRS Regulations provide that some nominal goods and services received may be disregarded, i.e. ignored as being a benefit received by the donor. However, the examples used in the Regulations are pretty vague and do not provide much comfort.  For example, intangible religious benefits, or some ‘membership benefits’ may be disregarded. But football tickets given to a donor in exchange for his QCD will cause the contribution to not be deductible. Nor is it possible for a QCD to be a part of a split-interest gift, e.g. a charitable gift annuity, or a charitable remainder trust arrangement.
7. Only if a Receipt is Received: As noted just above, all of the other charitable giving tax deduction rules, but one, apply to QCDs. Thus, if the QCD to the charity is for more than $250.00, the charity must provide a contemporaneous written acknowledgement  to the donor for the QCD. That ‘receipt’ must be in the donor’s hand before the donor files his or her income tax return for the year. No receipt = no income tax charitable deduction = no QCD. The only ‘exception’ to the normal charitable giving rules and limitations for a QCD  is that there is no income percentage limitation on a QCD- just the maximum $100,000 charitable gift for the year from the donor’s IRA.
8. Only Up to the Maximum RMD?: If the donor wishes to be very generous with their charitable giving by making a QCD in excess of their RMD for the year, they should consider other charitable giving techniques that may be more tax-efficient. For example, the donor might be better off making a charitable gift of appreciated marketable securities rather than using more of their IRA funds, since that excess distribution will be subject to the percentage income limits of the Tax Code for charitable gifts.
9. Only if No IRA Deductible Contributions Have Been Made: If the IRA owner has made any deductible IRA contributions after the year in which they reach age 70 ½ (starting in 2020), the QCD income exclusion to which the IRA owner would otherwise be entitled is reduced, dollar-for-dollar, by the amount of those tax deductible IRA contributions made by the owner.

Example: Mark, age 73, makes a $10,000 QCD in 2022, his first QCD since 2018. Because Mark made a $6,000 tax deductible IRA contribution in 2020, only $4,000 of Mark’s QCD will be excluded from his income in 2022. In sum, the tax benefits of deductible IRA contributions after age 70 ½ effectively cancel the tax benefit of equivalent QCDs made in the same year or later years.

One last practical problem is that when a QCD is made, it is reported to the IRS on a Form 1099-R, but no where on the face of that tax form is it reported as a QCD. Therefore, the burden falls on the IRA owner to let their tax return preparer know that the distribution reported on the Form 1099-R is a QCD and thus not included in the owner’s taxable income for the year.

Conclusion: A lot of charitable giving takes place as the calendar year comes to a close. A QCD is an excellent way for many older Americans to support their favorite charities. There are not that many ‘rules’ that govern QCDs, but the rules that do apply should be carefully navigated when an individual makes a QCD.