10 Things Advisers Should Know About Qualified Charitable Distributions

 

Do you have clients with charitable IRAs? If so, you should inform them about Qualified Charitable Distributions (QCDs). If advisors overlook this powerful strategy, their clients could miss out on a useful tax advantage. Here are 10 things every advisor should know about QCDs.

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1. A QCD is a way to transfer IRA funds to charity tax-free. When a QCD is done, the amount is excluded from income. Excluding the income is an even better tax benefit than receiving tax deductions because it keeps adjusted gross income (AGI) lower. This allows a customer to take advantage of more AGI-based tax benefits, resulting in lower taxes. Many older clients stop specifying and use the standard deduction instead. A QCD offers a way to still get a tax benefit for a charitable contribution. (However, no additional deduction can be made for the charitable contribution when a QCD is made.)

2. QCDs are available to IRA owners and beneficiaries 70 and older. While the Secure Act has postponed the age at which required distributions must begin to age 72, the age for QCDs remains unchanged at age 70½. This requirement can be confusing for clients because it requires that the person is actually 70 years old when the QCD takes place. A QCD cannot be done earlier, even if the person turns 70½ years later in the year.

IRA beneficiaries can also do QCDs. Many clients who inherit an IRA may not be aware of this. The beneficiary must be 70 years old and the age of the deceased IRA owner does not matter.

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3. Deductible IRA contributions after age 70½ can reduce QCDs. The Secure Act has abolished the age limit for traditional IRA contributions. However, for those who make both QCDs and IRA deductible contributions, the rules now limit the portion of the QCD that is excluded from income, effectively creating a taxable QCD.

Advisers should tell clients not to make deductible IRA contributions after 70 if they also do QCDs. The tax benefit of QCD can be reduced. Older clients who do QCDs and want to make IRA contributions should be encouraged to contribute to Roth IRAs instead. Roth IRA contributions do not disrupt QCDs.

4. QCDs cannot be done from employer plans or active SEP or SIMPLE IRAs. Customers who want to do a QCD from their 401(k) or other employer plan will be out of luck. This is an IRA tax benefit only and is not available for “active” SEP or SIMPLE IRAs. (A SEP or SIMPLE is active if a contribution is made for the year.) A possible solution for advisors could be for the client to do a direct rollover from the plan to an IRA or a transfer from the active SEP or SIMPLE to a IRA. Then the QCD can be done from the IRA.

Another limitation is that QCDs only apply to taxable amounts in IRAs. After-tax dollars in an IRA are not eligible, and pre-tax IRA dollars are considered QCD first. This is an exception to the pro-rata rules that normally apply to IRAs. As such, a QCD can be a good strategy for isolating the after-tax base in a traditional IRA and converting funds into a Roth IRA tax-free.

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5. QCDs are limited to $100,000 per person, per year. There is no problem with smaller QCDs and no problem with multiple QCDs, as long as the total does not exceed $100,000. However, some IRA custodians may have limits on the size and number of QCDs. For a married couple where each spouse has a separate IRA, each spouse can contribute up to $100,000 from their own separate IRAs.

>> See: Five IRA Rules for Spouses

6. A QCD must be done through a direct transfer from the IRA to the charity. The money must go immediately. A customer cannot accept a payment made payable to him and then give the money to charity. (Although a check paid to the charity can be mailed to the owner of the account for delivery.)

7. QCDs cannot be provided to private foundations that provide grants, donor-advised funds, or charitable donation annuities. Make sure customers understand these limitations. A QCD to an ineligible recipient will result in an unexpected taxable distribution.

8. A QCD from an IRA may meet a Minimum Distribution Requirement (RMD). This is good news for customers who don’t need their RMD or want the tax bill. However, timing matters here. Once an RMD is taken, that income cannot be offset against a future QCD.

Consultants should identify and contact all customers who may be eligible for a QCD before taking any action. Recommend that the QCD be completed as early in the year as possible.

This reduces the chance that someone will miss the opportunity to offset RMD earnings with a QCD or the chance that someone will be forced to take extra dollars later in the year.

9. The charity substantiation requirements apply. Clients will want to keep good records in case the IRS has questions in the future. Advisers must supervise all clients doing QCDs to ensure that the charity provides concurrent written confirmation by the time the tax return is filed. The charitable contribution should have been fully deductible had it not been made through an IRA. The taxpayer does not get any benefit back.

10. There is no special code for a QCD on Form 1099-R. The fact that there is no special code on the 1099-R for custodians to report a QCD creates a golden opportunity for advisors to add value. During the busy tax season, with no information appearing on Form 1099-R, tax preparers can easily miss a QCD on a tax return. This can result in an erroneous taxable IRA distribution and no itemized deduction for the QCD (because the transfer went directly from the IRA to charity and was missed by the tax preparer).

About the author: Sarah Brenner, JD is director of retirement education at Ed Slott and Company. She has spent nearly 20 years helping clients resolve complex technical IRA questions. She is a contributing writer to many IRA texts, articles and training manuals and has been cited in national financial and tax publications such as CCH IRA Guide. She is an accomplished speaker who has educated thousands of financial industry professionals including attorneys, CPAs, bankers, financial advisors, and brokers on retirement plan rules. Sarah has been commended for her ability to convey complex laws in an easy-to-understand manner and provide practical strategies for clients.

Sarah is a contributing writer and editor for Ed Slott’s IRA Advisor newsletter, distributed to thousands of financial advisors across the country, and writes for various parts of the company’s website, www.irahelp.com.

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