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

11-Jun-20

Qualified Charitable Distributions: Yes, Even in 2020

Take-Away: Despite the waiver of required minimum distributions in 2020, an individual age 70 ½ and above can still make qualified charitable distributions from their IRA.

Overview: A qualified charitable distribution (QCD) provides a great tax break. A QCD will satisfy the IRA owner’s required minimum distribution (RMD) for the year. The QCD will not be reported by the IRA owner as taxable income, but the IRA owner will not claim the QCD as a charitable deduction. Since most people no longer file itemized tax returns, instead claiming the large standard deduction, the loss of the ability to claim the charitable deduction is no big deal. The tax benefit from the QCD arises from the reduction of the IRA owner’s adjusted gross income for the year by not having to report the QCD portion of their RMD as taxable income.

Potential Tax Benefits by Reducing AGI: By not having to report an RMD as part of the IRA owner’s taxable income for the year, his/her adjusted gross income for the year will be lower. A lower adjusted gross income (AGI) reported by the individual may:

  • Lower Income Tax Bracket: Expose the individual to a marginally lower federal income tax bracket;
  • Avoid 3.8% NII Tax: Reduce their exposure to the 3.8% Medicare surtax on net investment income;
  • Avoid Deduction Phase-Outs: Reduce their exposure to phrase-outs for some income tax deductions;
  • Deduct Medical Expenses: Enhance their ability to claim itemized deductions for medical expenses (deductible above 7.5% of AGI);
  • Deduct Qualified Business Expenses: Enhance their ability to claim an IRC 199A qualified business deduction, or minimize the phase-out of that deduction; and
  • Minimize Medicare Surtaxes: Reduce their exposure to higher Medicare Part B and Part D premium surcharges.

Qualified Charitable Distribution Rules: Several conditions need to be met in order for an individual to make an qualified charitable distribution (QCD.) Those basic rules include:

  • Age 70 1/2: The individual must be at least 70 ½ years of age. This is not just turning age 70 ½ in the year of the gift, the individual must actually be over that age in order to qualify.
  • Amount Limited: The maximum amount to be given is no greater than $100,000 per individual, per year. If spouses each had IRAs and they were over age 70 ½, that married couple could gift $200,000  to charities in a single calendar year.
  • Only IRAs: The charitable gift can be made from a traditional IRA, a Roth IRA (see below) and an inactive SEP IRA and an inactive SIMPLE IRA. Inactive means that no deductible contribution was made to the SEP/SIMPLE IRA in the same year a QCD is made from that IRA account.
  • Not Qualified Plans: No QCDs can be made from a qualified plan like a 401(k) account. However, funds can be rolled-out of a qualified plan to an IRA from which QCDs can be made.
  • Only Direct Transfers: A QCD can be made only through a direct transfer of funds from the IRA custodian to the qualified charity. A distribution cannot be taken by the account owner, and then used to make a QCD. The distribution will be taxed to the IRA owner, and the owner will then have charitable income tax deduction, but only if the owner then itemizes his/her taxes for the year.
  • Qualified Charity: The QCD must be made to a qualified charity. Excluded from a qualified charity are donor advised funds (DAFs), private foundations (PFs), and charitable gift annuities (CGAs) .
  • Only Pre-tax Dollars: Only pre-tax dollars held in an IRA are available for a QCD. This is an exception to the so-called pro rata rule which prevents an IRA owner from withdrawing only pre-tax (or after-tax) dollars from the IRA which holds both pre and post-tax contributions. Consequently,  a QCD can only be made from the taxable portion of a Roth IRA.
  • No ‘Quid Pro Quo:’ The IRA owner cannot receive anything of value in exchange for the QCD, i.e., there is no quid pro quo.

Examples: A couple of simple examples of these conditions follow:

  • Age 70 ½ : Dean is the beneficiary of his  deceased brother’s IRA. Dean is age 70. Dean will not reach age 70 ½ until October 31, 2020. Dean cannot make a QCD until October 31, 2020. Note that this is the case even though Dean’s brother was over age 70 ½ at the time of his death. Dean can make a QCD even though RMDs are waived for 2020.
  • No Quid Pro Quo: Mike, age 75, makes a QCD to MSU of $7,500. As a sign of its appreciation, MSU sends to Mike two box seats tickets for a MSU football game this fall. By receiving the football tickets, Mike is in violation of the ‘no quid pro quo’ rule, and the full $7,500 gift to MSU is taxable to Mike (with a possible corresponding income tax charitable deduction, less the value of the football tickets, if Mike itemizes his taxes for the year.)

Taxable QCDs: One of the changes to the QCD rules caused by the SECURE Act is to make some QCD’s taxable. Specifically, the SECURE Act eliminated the limitation on funding an IRA after age 70. Accordingly, an individual over age 70 and who is still working can contribute  some of their earnings to an IRA as a pre-tax contribution. However, as noted above, that individual can also make a QCD from his/her IRA. Congress was apparently afraid of a ‘double dip’ by permitting an individual to make a deductible contribution to an IRA and in the same year also make a QCD from their IRA. To prevent this ‘double dip’ scenario, the SECURE Act limits the amount of tax-free QCDs if an individual also makes a post-age 70 ½ deductible IRA contribution. To make things more complicated, all post-age 70 ½ deductible IRA contributions made in years before a QCD is made are aggregated in calculating the offset to the QCD.  In short, each year’s post-age 70 ½ IRA contribution is aggregated and used to convert QCDs made in future years into partially, or fully, taxable distributions. Two examples follow with regard to these calculations:

  • No ’Double Dip:’ Dan attains age 70 ½ in 2020. Dan makes a QCD of $10,000 to Kalamazoo College this year. Dan also makes a $7,000 tax deductible contribution to his IRA in 2020. While K-College receives the full $10,000, the tax-free portion of Dan’s QCD is reduced by the $7,000 deductible contribution made to Dan’s IRA. Consequently, only $3,000 is excluded from Dan’s taxable income for 2020; the remaining $7,000 of the QCD distribution is taxable to Dan.
  • Aggregate Post-Age 70 ½ IRA Contributions: Ron turns age 70 ½ in 2020. Ron makes a $7,000 deductible IRA contribution in each of the years 2020, 2021, and 2022. Consequently, Ron has a total of $21,000 contributions in post-age 70 ½ deductible IRA contributions. In 2022, Ron decides to make a $15,000 QCD to Western Michigan University. Ron’s entire QCD to Western will be taxable income to him. That is because $15,000 of Ron’s $21,000 post-age 70 ½ deductible IRA contributions will be applied to convert Ron’s QCD into a full taxable distribution. This ‘conversion’ of Ron’s future QCDs will continue until all of Ron’s post-age 70 ½ deductible IRA contributions are ‘used up.’

Conclusion: To dispel any confusion, an individual age 70 ½ + can make a QCD in 2020, even though RMDs are waived for this calendar year. Several income tax benefits can result from making a QCD. Caution is needed, however, if an individual over age 70 ½ makes a tax deductible IRA contribution since that contribution will negate the anticipated income tax savings achieved with a QCD. It is important to note, in closing, that the CARES Act also created a one-time ‘above the line’ charitable income tax deduction of $300, in addition to the QCD, which does not lessen the value of making a QCD.