Qualified Charitable Distributions (QCDs) came into the IRS Code with the Pension Protection Act of 2006. As of the enactment date, August 17, 2006, qualifying charitably-minded taxpayers could elect to make charitable contributions directly to their charity of choice. If so, taxpayers would not be required to take such distributions into income nor would they deduct said amounts.
Taxpayers qualifying for such treatment were limited to those over 70 1/2 years old during the year. The distributions could satisfy the RMD (required minimum distribution) requirements for the year. The apparent potential advantages included being able to reduce exclusion items limited by AGI, possibly reduce taxable Social Security benefits, reduce possible itemized deduction limitations and to possibly maximize the benefit of the standard deduction. To the latter point, a taxpayers whose itemized deductions without regard to charitable contributions are below the standard deduction could use the QCD to satisfy their RMD requirements while still taking advantage of the standard deduction.
The QCD provisions were allowed to expire after December 31, 2006 but were retroactively reinstated for 2008 and 2009 by the Emergency Economic Stabilization Act on October 3, 2008. The Tax Act of 2010 extended them further for 2010 and 2011. The American Taxpayer Relief Act of 2012 was enacted on January 2, 2013 and included a provision to retroactively allow QCDs made by January 31, 2013 to be considered as 2012 transactions. The provision was further extended by the Tax Increase Prevention Act of 2014, extending the benefit to December 31, 2014. More recently, the Protecting Americans from Tax Hikes Act of 2015 made the provision permanent.
The QCD Provision in Operation – Estate Tax
In recent years, the taxable threshold for Federal Estate Tax has been increased to the point that fewer taxpayers incur State or Federal Estate or Inheritance Tax. However, taxpayers should not ignore the fact that there are other inheritance related options when they have an asset mix that includes retirement accounts. Furthermore, the estate tax thresholds could always be reduced by Congress in later years.
Retirement benefits are to be contrasted with other assets that can be passed to noncharitable beneficiaries free of income tax. For example, an individual inheriting stock worth $300,000 from his parent (which stock was purchased by the parent for $100,000) won’t have to pay income tax on the $200,000 appreciation. The stock could potentially receive a “step up” in basis upon the death of a decedent. That’s not so for retirement benefits. They are subject to both income tax and estate tax. A special income tax deduction for the estate tax helps noncharitable beneficiaries but the combined income and estate tax can still be quite substantial. Even for a taxpayer who regularly donates appreciated property, it may well be more beneficial for himself and his heirs to make QCDs rather than to donate appreciated property. Because of the tax bite, someone who plans to make charitable gifts should consider naming a charity as beneficiary of his IRA or retirement plan to gain these advantages:
-The retirement benefits going to the charity won’t be subject to federal estate tax and generally won’t be subject to state death taxes.
-The estate won’t be considered to receive taxable income when the benefits are paid to the charity.
-The retirement account owner’s surviving spouse, children and others who may be beneficiaries of the estate won’t be considered to receive taxable income when the retirement benefits are paid to the charity.
-The charity won’t have to pay federal income tax on distributions from the qualified plan or IRA and generally won’t have to pay state income taxes.
For one who is not in a position to leave his entire retirement benefits to a charity, there these options still remain:
-An individual with two or more retirement plans (e.g., an IRA and a profit-sharing plan, or two IRAs) can leave one to a charity and the other(s) to family members.
-An individual with a single IRA can split it into two IRAs and leave one to a charity. This can be achieved tax-free through a rollover or a trustee-to-trustee transfer.
-A married individual can have his benefits paid to a QTIP trust for his spouse with a charity to receive the benefits that remain at the death of the surviving spouse. The marital deduction will shield the benefits from estate tax when the individual dies. When the surviving spouse dies, the remaining benefits will go to the charity free of estate and income tax.
-An individual can have his will establish a charitable remainder trust at his death to provide a noncharitable beneficiary with a fixed annuity for a set number of years (not to exceed 20) or for life, with the remainder going to charity.
Finally, the QCD Income Tax Provisions:
Another popular way to transfer IRA assets to charity is via a tax provision which allows IRA owners who are 70 1/2 or older to direct up to $100,000 per year of their IRA distributions to charity. These distributions are the qualified charitable distributions, or QCDs, as noted above. The funds passed directly to charity count toward the donor’s required minimum distribution (RMD), but doesn’t increase the donor’s adjusted gross income or generate a tax bill.
Keeping the donation out of the donor’s AGI is important because doing so can (1) help the donor qualify for other tax breaks (for example, having a lower AGI can reduce the threshold for deducting medical expenses, which are only deductible to the extent they exceed 7.5% of AGI (through 2018, and 10% of AGI thereafter)); (2) reduce taxes on the donor’s Social Security benefits; and/or (3) help the donor avoid a high-income surcharge for Medicare Part B and Part D premiums (which kick in if AGI is over certain levels).
Further, because charitable contributions will not yield a tax benefit for those taxpayers who will no longer itemize their deductions (and thanks to the larger standard deduction after 2017, this will be the case for many taxpayers), those who are age 70 1/2 or older and are receiving RMDs from IRAs, may gain a tax advantage by making annual charitable contributions by way of a QCD from an IRA. This charitable contribution will reduce RMDs by a commensurate amount, and the amount of the reduction will be tax-free.
Does this apply to all IRAs?
The question arises whether the QCD provision applies to inherited IRAs. Commentators seem to agree that inherited IRAs are not excluded from the provision, and cite IRS Notice 2007-7, 2007-1 CB 395 — IRC Sec(s). 72; 402; 403; 411; 415; 417; 457, 01/10/2007. The provision does NOT include distributions from a simple retirement plan or a simplified employee pension.
QCDs and Tax Reform
QCDs are more likely to be advantageous now under Tax Reform. The increases in the Standard Deduction make them potentially more beneficial in situations where taxpayers’ other itemized deductions are below the Standard Deduction. The previous other potential advantages also remain: reduction in exclusions that are tied to Adjusted Gross Income, possible reduction in taxable Social Security, among others. The limitation on itemized deductions has been eliminated for 2018. The $10,000 maximum deduction for state and local taxes will likely also cause some taxpayers to utilize the Standard Deduction in 2018 where they otherwise might not have done so in prior years.
In the balance, qualifying taxpayers would do well to consider making QCDs for income and estate planning reasons.
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