Introduced by the Pension Protection Act of 2006, P.L. 109-280, the qualified charitable distribution (QCD) provisions under Sec. 408(d)(8) were repeatedly extended, sometimes retroactively, until they were made permanent by the Protecting Americans From Tax Hikes Act of 2015 (part of the Consolidated Appropriations Act, 2016, P.L. 114-113). Before 2018, the QCD's strategic importance lay primarily in the fact that it could help older taxpayers meet their philanthropic goals while also satisfying individual retirement account (IRA) required minimum distributions (RMDs).
Since the passage of P.L. 115-97, known as the Tax Cuts and Jobs Act of 2017 (TCJA), QCDs can offer an additional benefit. For tax years 2018 through 2025, the TCJA nearly doubles the standard deduction (for 2018, to $24,000 for married couples filing jointly, $18,000 for heads of household, and $12,000 for all other individuals, indexed for inflation in subsequent years) and caps the itemized deduction for state and local taxes (SALT) at $10,000 annually. Thus, many taxpayers who previously itemized deductions will now find it advantageous to take the standard deduction instead. These taxpayers will no longer deduct their charitable contributions, but via a QCD, some of them can still make those contributions with pretax dollars, resulting in significant tax savings.
Example: For the 2018 tax year, a couple plan to file jointly. They are both age 75 and anticipate adjusted gross income (AGI) of $125,000, including $60,000 in RMDs. Although they will not itemize deductions, they still plan to make charitable contributions totaling $5,000. They will report federal taxable income of $98,400 ($125,000 AGI, less a standard deduction of $26,600 ($24,000 plus an additional standard deduction of $1,300 each for being over 65)), resulting in federal tax of $13,527.
If the couple instead make the charitable contributions using QCDs, they will include the $5,000 in their RMDs but exclude it from gross income, resulting in taxable income of $93,400 and federal tax of $12,427, a tax savings of $1,100.
The QCD requirements are found in Sec. 408(d)(8):
- No more than $100,000 in aggregate QCDs may be excluded from gross income in a tax year (Sec. 408(d)(8)(A)).
- A QCD may be made from any type of IRA, other than a simplified employee pension under Sec. 408(k) or a SIMPLE retirement account under Sec. 408(p) in which the taxpayer is still active and receiving employer contributions (Sec. 408(d)(8)(B); see also Notice 2007-7, Q&A-36). It can be made from a Roth IRA (although Roth distributions generally are already tax-free and are not subject to RMDs), an inherited IRA, a rollover IRA, or a qualified employer plan that permits employees to make voluntary contributions to separate accounts or annuities (a "deemed IRA" under Sec. 408(q)).
- A distribution will be treated as a QCD only if it otherwise would be includible in gross income (without regard to Sec. 408(d)(8)(A)). Sec. 408(d)(8)(D) provides a special rule by which amounts transferred are treated as coming first from taxable funds instead of proportionately from taxable and nontaxable funds (this is different from the rule used for non-QCD purposes).
- The distribution must be made directly by the IRA trustee to an organization described in Sec. 170(b)(1)(A), other than a Sec. 509(a)(3) supporting organization performing functions of related charities or a Sec. 4966(d)(2) donor-advised fund or account (Sec. 408(d)(8)(B)(i)and Notice 2007-7, Q&A-35). However, a check from the IRA payable to the charity and delivered to it by the IRA owner will be considered a direct trustee payment (Notice 2007-7, Q&A-41).
- The distribution must be made on or after the date the IRA beneficiary attains age 70½. After the IRA owner's death, a beneficiary of an inherited IRA who has attained age 70½ can make a QCD (Notice 2007-7, Q&A-37).
- A deduction under Sec. 170 must have been allowable for the entire distribution, determined without regard to the percentage-of-AGI limitations and the limitations of Sec. 408(d)(8) (e.g., there can be no benefit in exchange for the contribution).
- Taxpayers may not take a deduction under Sec. 170 for any amount paid as a QCD. However, QCDs must satisfy the Sec. 170(f)(8) substantiation requirements (e.g., contributions of $250 or more must be substantiated with a contemporaneous written acknowledgment from the donee meeting the requirements of Sec. 170(f)(8)(B) (see Sec. 408(d)(8)(E) and Notice 2007-7, Q&A-39).
The following factors should also be taken into account when determining whether to make a QCD:
- The lower AGI resulting from a QCD strategy may lessen the effect of phaseouts and limitations on tax and other benefits, including lower taxable Social Security benefits (Sec. 86(a)), larger deductions for medical expenses (Sec. 213(a)) and passive losses (up to $25,000) from rental real estate activities in which the taxpayer actively participates (Sec. 469(i)), lower net investment income tax (Sec. 1411(a)), larger contributions to Roth IRAs (Sec. 408A(c)(3)), and lower Medicare Part B and prescription drug coverage premiums (see Medicare Premiums: Rules for Higher-Income Beneficiaries, available at ssa.gov.
- There is no carryover provision for any portion of the $100,000 annual limitation not used in a given year. However, the limit applies to each individual IRA account owner, so both spouses of a married couple filing jointly can each make up to $100,000 in QCDs each year if their QCDs come from their respective IRA accounts.
- If taxpayers plan to make a QCD from funds currently in a non-IRA account and want the QCD to qualify toward an RMD, they should be wary of rollover timing, as RMDs are determined based upon the IRA's account balance as of Dec. 31 of the calendar year immediately preceding the calendar year for which distributions are required (Regs. Sec. 1.408-8, Q&A-6).
- Taxpayers should carefully consider whether Roth conversions make sense for them in the long run, given that the QCD has been made permanent.
- Tax preparers should instruct clients to accurately report QCD amounts and retain in their records IRA statements showing the QCDs, along with required substantiation under Sec. 170, since QCDs generally are not distinguished as such on Form 1099-R, Distributions From Pensions, Annuities, Retirement or Profit-Sharing Plans, IRAs, Insurance Contracts, etc. QCDs should be included in the amount reported on line 15a of Form 1040, U.S. Individual Income Tax Return (2017), but not in the taxable amount reported on line 15b ("QCD" should be entered next to line 15b).
- Not all states conform with federal law with respect to QCDs.
- Distributions from IRAs may incur administrative fees and charges, such as early redemption fees or sales charges on funds or securities. Also, check with the IRA trustee as to timing, as some trustees may not be willing to process QCDs requested late in the calendar year.
QCDs FOR THE STATUS QUO
CPAs' tax clients who have long been accustomed to itemizing their deductions including charitable contributions may be dismayed that their philanthropy no longer is specifically taken into account at tax time, now subsumed under the higher standard deduction and limited SALT deduction. For those who are of the right age and have one or more IRAs, a QCD may be the answer to fulfilling their impulses to be both charity-generous and tax-thrifty.
Kim T. Mollberg, CPA, CGMA, CMA, MBT, is an associate professor of accounting at Minnesota State University Moorhead in Moorhead, Minn.
To comment on this article or to suggest an idea for another article, contact Paul Bonner, a JofA senior editor, at Paul.Bonner@aicpa-cima.com or 919-402-4434.