Post-Reform Workaround for Tax-Preferred Charitable Gifts This Holiday Season

by Prof. Robert Bloink and Prof. William H. Byrnes

As we approach the end of the second full year since the major 2017 tax reform legislation was made effective, many clients are fully aware that they might not be eligible for the federal tax deduction for charitable donations every year—unless those donations are very substantial. Charitably minded clients who have contributed to an IRA and reached age 70 ½, however, can continue to receive a tax benefit for even smaller charitable donations every year. For clients interested in supporting a charity and simultaneously reducing taxable income—without itemizing tax deductions—the December 31 deadline for making a qualified charitable distribution (QCD) is fast approaching—so the time to act is now.

The Qualified Charitable Distribution Mechanics

Late in 2015, Congress made the QCDprovisions permanent, so that charitably-minded clients can direct up to $100,000 in IRA funds per year to charity and reap the tax benefits even post-tax reform. The $100,000 cap is a per-person cap, so that married taxpayers can direct up to $200,000 to charity each year so long as each spouse has their own IRA.

If a client is over age 70 ½, a transfer made directly from the client's IRA to a qualified charity (generally, 501(c)(3) organizations, but not donor-advised funds, foundations or charitable gift annuities) will count toward the client's RMD and is entirely nontaxable. Beneficiaries who are over age 70 ½ are also permitted to make QCDs, so long as the beneficiary also meets all other basic requirements for the transaction

QCDs can only be made from a traditional IRA or an inherited IRA. Tax-preferred accounts such as SIMPLE IRAs, SEP IRAs and Roth IRAs generally do not qualify, although QCDs can be made from SEP IRAs and SIMPLE IRAs that are not ongoing. To be ongoing, an employer must have made a contribution to the SEP or SIMPLE IRA for the plan year when the contribution would be made.

In order to have the distribution counted as aQCD, the client must have the amount transferred directly to charity and report that amount on his or her tax return as aQCD. The full amount is reported on the client's Form 1040 under IRA distributions, but the client enters "0" if the entire amount was aQCD(noting "QCD" next to that line).

As with any other charitable contribution, the client should obtain substantiation from the charity that confirms the transaction from the charity. The documentation should state that no goods or services were provided in exchange for the donation. It’s important that the client save all documentation relating to the transaction.

Reaping the QCD Tax Benefits

The QCD provides a valuable tax benefit for charitably minded clients who are unable to itemize because of the higher standard deduction post-reform. Clients who reached age 70 ½ during 2019 can take the QCD by December 31—and clients whose first RMD was not due until April 1, 2019 (i.e., clients who turned age 70 ½ in 2018) can still take a QCD for 2018 by year-end.

While the client will not be entitled to the typical federal income tax deduction for charitable donations if theQCDstrategy is used, the QCD amount is not included in the client's income for the year—and it satisfies the client’s required minimum distribution obligations. This can help the client avoid jumping into a higher income tax bracket, which could also trigger application of higher capital gains rates and the net investment income tax, as well as higher Medicare surcharges and phaseouts of other valuable tax benefits.

Importantly, clients should remember that the amount of the QCD can exceed the amount of the client’s RMD for the year (it just cannot exceed the $100,000 cap). However, the QCD can only include taxable IRA funds (meaning that the client’s basis in the IRA, including nondeductible contributions, cannot be transferred to the charitable organization as a QCD). When a client’s IRA contains both deductible and non-deductible contributions, the usual pro-rata rules do not apply and the QCD is simply taken from the deductible portion first.

The direct transfer element of the transaction is important for ensuring that the client receives the valuable tax benefits of QCD treatment—the amounts should be transferred directly from the IRA custodian to the charity. The client should never receive a check directly from the IRA unless that check is made payable to the charity.

Conclusion

The QCD option provides a valuable tax benefit for clients who are required to take RMDs but don’t have enough deductions to itemize. The deadline is fast approaching, so clients with charitable giving goals should begin selecting their charitable beneficiaries now.