IRA owners who are age 70½ or over can transfer up to $100,000 per year to charity to reduce their taxable income. For a married couple, if both spouses are age 70½ and have IRAs, each spouse can exclude the $100,000 for a total of up to $200,000 per year. These transfers, known as qualified charitable distributions or QCDs, offer end-of-the year tax savings and can count toward required minimum distributions (RMDs) that taxpayers who are age 72 must make each year. Think of it as a tax-free charitable rollover of IRA funds.
How to Make a Qualified Distribution
Distributions from traditional IRAs are usually included in taxable income. With QCDs, the distributions are tax-free if they are paid directly from the IRA to an eligible charitable organization. Eligible organizations are public charities, otherwise known as a Sec. 501(c)(3) organizations, such as churches, nonprofit hospitals, schools and science organizations. The IRA owner must contact their IRA trustee to have them distribute the funds directly to the charity.
The distribution will not qualify for tax-free treatment if the funds are distributed to the IRA owner, even if the IRA owner gives the funds to the charity. The IRA owner will have to include the distribution in taxable income but can take a charitable deduction for the contribution if they itemize their deductions. Charitable deductions are subject to limitations depending on a taxpayer’s income level.
The QCD option is available regardless of whether the IRA owner itemizes deductions on Schedule A. Transferred amounts are not taxable, but no itemized deduction is available for the transfer.
How to Report Qualified Distributions
When an IRA distribution is made, the owner will receive Form 1099-R from the IRA trustee that shows all distributions made during the calendar year. The amount is then entered on Form 1040 but is not included in adjusted gross income if it is a QCD. If the distribution is made to the charity before the end of the year, it will go on the 2022 tax form. If it is made after December 31, 2022, it will go on the 2023 tax return.
Get Receipt from the Charity
For record-keeping purposes, the IRA owner should get a receipt from the charitable organization in the form of a written acknowledgement of the contribution. The acknowledgement should include the date and amount of the contribution and should indicate whether the donor received anything of value in return.
QCDs v. Charitable Deductions
The issue of whether a qualified distribution is more beneficial than a traditional charitable deduction depends on the individual taxpayer’s circumstances. Generally, traditional IRA distributions are fully included in adjusted gross income (AGI) and are taxable as ordinary income. Things to consider include your income level and the amount of your yearly required minimum distributions if you are age 72 and above. IRA distributions included in income can push you into a higher tax bracket, subjecting you to a higher tax rate and increasing the potential tax on social security benefits. Having a higher adjusted gross income (AGI) also can affect your eligibility for other deductions and credits.
In addition, charitable deductions require itemization while tax-free QCDs do not. Finally, taxpayers who fail to make RMDs each year are subject to penalties, so making a distribution to charity that counts as an RMD can be beneficial if you do not need the extra income.
Your Frazier & Deeter tax advisor can help you determine the best use of your IRA funds to meet your financial and personal goals. Contact us to learn more.