Most people no longer receive tax benefits for their charitable gifts because they take the standard deduction and do not itemize their deductions.
The qualified charitable distribution is a tax benefit that allows some owners of individual retirement accounts to use their IRAs to make charitable contributions by directly transferring IRA funds to qualifying charities. The IRA funds that go to the charity are excluded from income. This exclusion from income provides a better tax benefit than an itemized deduction because the QCD reduces adjusted gross income, or AGI.
IRAs are the best funds to give to charity since these funds are generally pre-tax. The QCD provision allows the IRA funds to be withdrawn at a zero-percent tax rate and can offset the income from a required minimum distribution.
The foundation of all good tax planning is to always pay taxes at the lowest rates, so any time taxable IRA funds can be removed from the account without tax, that opportunity should be taken advantage of. QCDs allow that to be done and should be maximized by anyone making charitable gifts.
However, QCDs have their limitations. They are only available to IRA owners and IRA beneficiaries who are 70½ or older, and they are limited to $100,000 per person, per year (not per IRA account). QCDs aren’t permitted from company plans like 401(k)s or 403(b)s.
Now, but only for the remainder of 2021, this QCD tax benefit can be greatly expanded thanks to provisions in recent tax laws. This creates an opportunity to do what I call a mega QCD.” It’s not a QCD, so it’s not limited to $100,000 per year. In fact, it’s unlimited.
Here’s how it works and who can benefit.
The AGI limit on tax deductions for cash gifts to charity is currently 100%, but that ends at the end of this year. The CARES Act eliminated the prior 60% of AGI limit for 2020 and the Covid-related Tax Relief Act of 2020 enacted late in 2020 extended this benefit through the end of 2021, resulting in tax deductions of up to 100% of AGI for cash gifts.
So what does this have to do with QCDs? Nothing directly.
But the result of combining these two provisions creates a mega QCD opportunity allowing unlimited distributions from any retirement account (not just IRAs) to be given to a charity for a 100% tax deduction for those itemizing deductions.
A large charitable tax deduction could also allow more people to itemize deductions when those itemized deductions exceed the standard deduction amount. This in turn would free up other itemized deductions like state and local taxes and mortgage interest to be claimed, increasing the overall tax benefit.
For example, an IRA owner with a large IRA who wishes to use those funds to make large charitable gifts could withdraw $1 million from his IRA, give that $1 million to a qualified charity and receive a $1 million tax deduction, completely offsetting the income on the entire $1 million distribution from the IRA.
The downside is that this would naturally increase AGI, which could reduce or eliminate certain AGI-based tax deductions, credits, and other benefits. For example, deductions for medical expenses could be greatly reduced since these deductions are limited to amounts in excess of 7.5% of AGI. Medicare IRMAA surcharges for Parts B and D and taxation of Social Security benefits could also be increased. But in the overall tax planning picture, these items may be insignificant to high-net-worth or high-income individuals who wish to gain tax benefits for their large charitable gifts.
The ability to use unlimited amounts of funds in IRAs or company plans to give to charity and receive a 100% deduction (or up to 100% of AGI) will be a huge tax benefit for those who would normally make large charitable gifts but are not able to maximize the tax benefits.
WHO CAN BENEFIT MOST?
Generally, the mega QCD will be valuable to those who don’t qualify for a QCD because they are either under age 70½, want to use their 401(k) funds (if eligible for plan withdrawal) for making charitable gifts, or would like to give more than the annual $100,000 QCD limit. 401(k) and IRA beneficiaries can benefit as well.
The big picture tax benefit of the mega QCD is the ability to reduce taxable retirement account balances at a zero percent tax rate by using these funds to make charitable gifts. This will bode well in the future if tax rates increase on these growing IRA and 401(k) balances, which is likely.
DOUBLE TAX BENEFIT: USE THE QCD AND THE MEGA QCD
Those who do qualify for the QCD can still use that for IRA transfers up to the $100,000 limit and then use the mega QCD to make gifts in excess of that amount. While a QCD can offset the tax on RMDs and exclude that from AGI, using the mega QCD does not. However, the corresponding itemized deduction for the charitable contribution can still offset the tax on the IRA or 401(k) distribution.
Caution: Don’t use the mega QCD if the client is under age 59½ because that could trigger a 10% early distribution penalty. Also, don’t use Roth IRA funds since there is no tax benefit to be gained. Roth distributions will generally be tax-free.
Be aware that the 100%-of-AGI limit for deducting cash gifts to charity does not apply to donor-advised funds or gifts to other supporting organizations.
This novel tax benefit will only be available for the rest of 2021, though, so use it or lose it! Spread the word to your clients.
Ed Slott on future client expectations
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Andrew is half-human, half-gamer. He’s also a science fiction author writing for BleeBot.