Unless you itemize deductions on your federal tax return, you don't currently receive tax benefits from making charitable contributions. That may be acceptable to you if you only donate for philanthropic reasons. But most people appreciate the tax advantages as well — if they can get them.
Fortunately, there's another way for older people to support organizations making a difference and qualify for tax benefits. You can make qualified charitable distributions (QCDs) from an IRA account to a qualified nonprofit. Let's take a look.
Normally, distributions from a traditional IRA are taxed at federal income tax rates topping out at 37%. These distributions can also cause net investment income tax (NIIT) and other complications. Therefore, if you don't need the income, you may want to postpone IRA distributions as long as federal law allows.
If you take distributions from an IRA directly and contribute the money to a charity, you may claim a deduction for the monetary contribution if you itemize deductions. In such cases, charitable contributions may offset your taxable income. However, since the Tax Cuts and Jobs Act was enacted, most taxpayers no longer itemize because the law raised the standard deduction.
By using QCDs, you avoid the "middleman" for a transfer of IRA funds to charity. If eligible, you can arrange with your IRA custodian for money to be sent directly from the account to a nonprofit organization. As long as certain requirements are met, the transfer isn't treated as a taxable distribution subject to federal income tax. Of course, you can't deduct the contribution as a charitable donation either, even if you itemize. Essentially, the process results in a "wash" for federal income tax purposes.
To qualify for this tax treatment:
In addition, Roth IRAs may be used for QCDs, but there's generally no tax advantage to using them for this purpose. In most instances, you'd be better from a tax perspective if you don't make a QCD from a Roth IRA. Instead, take the withdrawal first, then make the contribution directly to the charity. You'll be eligible to claim a charitable contribution deduction if you itemize.
If you're of an age to take required minimum distributions (RMDs) from a traditional IRA, there's good news: QCDs qualify as RMDs. As you may know, you must begin taking RMDs by April 1 of the year following the year in which you turn age 73, starting in 2023 (up from age 72 in 2022). Then you must continue to take RMDs in each succeeding year. RMDs are based on IRS life expectancy tables and the value of your IRA account on December 31 of the prior year.
Certain RMD rules also apply to beneficiaries who've inherited traditional IRAs. But mandatory lifetime distributions aren't required for participants in Roth IRAs. (Roth IRA beneficiaries must empty out their accounts under special rules.)
Also note that QCDs may reduce your adjusted gross income for other tax purposes. This can have a domino effect on your tax return, changing deductions and credits you may claim, as well as alternative minimum tax liability and imposition of the NIIT. If you're receiving Social Security benefits, these benefits are subject to tax under a complex formula. A QCD enables you to effectively lower your income for this calculation, thereby potentially reducing your tax liability.
If you're required to take RMDs, you might be looking for ways to reduce the amount you must take. QCDs may help, with the added benefit of advancing your philanthropic goals. Consult your tax advisor for more information.
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