Over Age 70 1/2? Consider a QCD for your IRA RMD

IRA: Individual Retirement Account
RMD: Required Minimum Distribution
QCD: Qualified Charitable Distribution

Sorry for the jargon! Please don’t tune us out—especially if you have an IRA and are over the age of 70 ½. As we have described in earlier articles, the Tax Cut and Jobs Act of 2017 (TCJA) will change the way many Americans file taxes. Before diving into the details, we’ll state the main point of this article: Charitable individuals who take an annual required minimum distribution (RMD) from their IRA should consider a qualified charitable distribution (QCD). This is especially the case for taxpayers who use the standard deduction instead of itemizing deductions.

QCD in Brief: Taxpayers over the age of 70 ½ are eligible to contribute up to $100,000 to a qualified charity directly from an IRA each year. (Note that “qualified charity” in this case does not include Donor Advised Funds or private foundations.) There are two advantages of the QCD. First, a QCD counts toward satisfying the taxpayer’s required minimum distribution for that year. Second, the QCD has the advantage of not increasing Adjusted Gross Income (AGI) as taxable IRA distributions do. Increasing AGI can result in “stealth taxes” such as an increase in the tax on Social Security benefits, higher Medicare premiums, and a reduction in medical expense deductions (which are allowed only to the extent they exceed 7.5% of AGI). In essence, the QCD allows the taxpayer to make a charitable contribution using pre-tax money. The contribution is not deductible, but, because the contribution is made with pre-tax money, the tax effect is equal to or better than making a deductible contribution with after-tax money. The QCD is usually better because it keeps income lower, resulting in more AGI-based tax benefits which results in a lower tax bill.

Taking the Standard Deduction Instead of Itemizing? Under the new tax law, it is expected that up to 95% of tax filers will take the standard deduction instead of itemizing deductions. This is up from 70%. The primary provisions of the new law that drive this change include:

• an increase in the standard deduction to $24,000 ($26,600 if over age 65) for couples filing jointly and to $12,000 ($13,600 if over 65) for single filers;
• a cap of $10,000 on the deduction of state and local taxes (SALT);
• preservation of the mortgage interest deduction for those who itemize—please note, mortgage limits have changed;
• preservation of the charitable contribution deduction for those who itemize;
• the elimination of most other itemized deductions.

The combined impact of the increase in the standard deduction and the cap on SALT deductions is significant. Many taxpayers will find that the sum of their itemized deductions no longer exceeds the amount of the standard deduction. Taking the standard deduction will therefore be an easy decision. For these taxpayers, previously popular deductible items such as state and local income taxes, property taxes, mortgage interest and even charitable contributions will become useless with regard to tax planning. And while most taxpayers will see lower tax bills under the new law, not being able to use those popular deductions will be a disappointment for many. Enter the QCD! In the case of charitable contributions, the QCD in effect “restores” a deduction for those taking the standard deduction and can result in meaningful tax savings when compared to gifting after-tax assets (cash or appreciated securities) to charity. In a “have-cake-and-eat-it-too” kind of way, the QCD allows taxpayers to enjoy both the standard deduction and avoid being taxed on that portion of their IRA distributions that are given directly to charity. Again, the QCD is only available for those taxpayers who are over age 70 ½.

Still Itemizing? Taxpayers whose permitted itemized deductions continue to regularly exceed the amount of the standard deduction will of course continue to itemize. These taxpayers should still consider the QCD by comparing the QCD method of making charitable contributions to making charitable contributions of cash or other after-tax assets. Because of the AGI-reducing phenomenon of the QCD (and the ability to reduce “stealth taxes”), even those who itemize will usually come out ahead with the QCD.

Keep Your After-Tax Assets. Give Away Your IRA. Another benefit of using IRA assets rather than after-tax assets for charitable contributions is that under current law, after-tax assets enjoy a step-up in basis at the death of the owner. Heirs will inherit these assets with a brand new cost basis. They could immediately sell with zero tax! In contrast, inherited Traditional IRA balances receive no step-up; distributions to heirs from inherited IRAs are taxed as ordinary income. In the long run, when it comes to taxes, the after-tax account is usually a “better friend” to our heirs than our IRA. Read more about the strategy of maximizing the growth of after-tax assets in Asset Location for Tax Efficiency: What You Need to Know.

A QCD Exception: A notable exception to QCD-gifting being preferable to gifting after-tax assets is in the case of large, concentrated, highly-appreciated stock positions. When these positions dominate a portfolio and hinder efforts to diversify, investors shouldn’t allow the “tax tail to wag the dog.” In these cases, gifting after-tax, highly-appreciated securities enables the taxpayer to 1) take a tax deduction equal to the fair-market value of the gift, 2) avoid paying the capital gains tax on the appreciated asset and 3) achieve desired levels of portfolio diversification by investing the cash from the IRA distribution. The aforementioned AGI-driven “stealth taxes” may creep in temporarily during the years when gifting appreciated stocks is chosen instead of the QCD, but in our view, this is a reasonable price to pay given the added financial certainty that can be achieved with a diversified portfolio.

Housekeeping with the QCD: It is very important to keep careful records of charitable contributions made from your IRA. IRA custodians (Pershing, Schwab, etc.) will not distinguish between taxable distributions and charitable distributions on the 1099R issued at the end of the year. This is the responsibility of the taxpayer. Just as with any charitable contribution, it is important to provide clear documentation to your tax preparer.

In summary, we think a QCD from your IRA RMD is PDC (pretty darn cool.) If you’d like to learn more about it, please let us know. As always, please consult your tax advisor before acting on the ideas presented in our articles.

Click on the links below to read more Bragg articles about the new tax bill:

Who Gets a Tax Cut?
February 2018
by Phillips M. Bragg, CFP^®, AEP^®

Tax Deduction “Bunching” – The Tax Cuts and Jobs Act of 2017
January 2018
by Mary Lou Daly, CPA, CFP^®

New Law Doubles the Estate Tax Exclusion Amount but Only Through 2025
January 2018
by Phillips M. Bragg, CFP^®, AEP^®

A Summary of The Tax Cut and Jobs Act of 2017
February 2018
by Phillips M. Bragg, CFP^®, AEP^® and Mary Lou Daly, CPA, CFP^®

Chained CPI Explained and the Impact on the New Tax Act
April 2018
by Jennifer Muckley, CFP^®, CTFA^®

Kiddie Tax Update
January 2018
by George W. Climer III, CFP^®

This information is believed to be accurate but should not be used as specific investment or tax advice. You should always consult your tax professional or other advisors before acting on the ideas presented here.