Optimizing the Tax Impact of Charitable Giving Under the New Tax Law
Written by Doug Custer, CFP
Beginning at age 70½, IRA owners must start taking Required Minimum Distributions (RMDs) each year from their IRA accounts. Unless you have made after-tax contributions in the past, these distributions are taxable as ordinary income. However, if you are charitably inclined, your RMDs can not only help you deduct more from your taxable income, but donate to a charity about which you’re passionate, as well. This is accomplished via Qualified Charitable Distributions (QCDs).
A Qualified Charitable Distribution is a portion of your RMD that is paid directly from an IRA to a 501(c)(3) charitable organization, without going to you first. Up to $100,000 per year of RMDs can be given directly to qualified charities this way without having to pay any income tax on those IRA distributions. In other words, QCD donations are made entirely with pre-tax (untaxed) dollars; therefore, they have the same tax impact as if you received money from your IRA and were able to deduct the entire gift from your taxable income.
What’s Old is New Again
QCDs were available prior to 2018, but the new tax law makes them more attractive to a much larger group of people. In years past, you could generally deduct donations to 501(c)(3) charities, as long as you itemized deductions on your tax return. Recent changes to the tax code make that more challenging. For one thing, the new rules limit (or eliminate) several other itemized deductions, including mortgage interest and professional fees. But the biggest change is that the new law nearly doubled the so-called “Standard Deduction” (SD), which is the amount you can automatically deduct if you don’t itemize. For single taxpayers, the SD jumped from $6,350 in 2017 to $12,000 in 2018. For married couples, it jumped from $12,700 to $24,000.
The only way you can itemize is if you have enough allowable deductions under the new law (including charitable contributions) to exceed the applicable Standard Deduction amount, and far fewer people do, especially retirees. If you are retired, there’s a good chance that you pay little or no mortgage interest, and you may not have deductible business or other expenses. Your charitable giving might be the only thing that gives you enough deductions to itemize.
But here’s the key—unless you have enough itemized deductions other than charitable donations to exceed the Standard Deduction to which you’re entitled, using QCDs for your charitable donations almost certainly makes more sense than itemizing. The reason is that QCDs give you the best of both worlds: you can use the new, higher Standard Deduction and your charitable contributions can come entirely from pre-tax dollars.
If you’re forced to take RMDs, directing part of the RMD to charity (via QCDs) reduces your taxable income dollar for dollar, whether you itemize or not. In short, if you’re past 70½, you should almost certainly be using QCDs for your charitable gifting.
Let’s say you’re a married couple with $80,000 per year of net taxable income, and not a lot of itemized deductions (other than, potentially, charitable donations). Claiming the standard deduction ($24,000) would lower your taxable income to $56,000. If you write a $10,000 check to charity, your taxable income would still be $56,000 because the SD amount is greater than your charitable contribution plus your other (limited) deductions. In this case, you would get no tax savings at all from that donation. Even if you have other deductible items totaling, say, $15,000, itemizing them along with your $10,000 donation would only give you $25,000 of itemized deductions, which is only $1,000 more than the SD. That means your taxable income would only be $1,000 less ($55,000 instead of $56,000) than if you just used the Standard Deduction. Remember, you get to either itemize or take the standard deduction (whichever is greater), not both.
If you’re past 70½ and have IRAs, part of your $80,000 in taxable income (let’s say $12,000 of it) comes from your Required Minimum Distribution (RMD). You could use a Qualified Charitable Distribution for the entire $10,000 donation (leaving only $2,000 of the $12,000 RMD taxable). This reduces your taxable income to $46,000 ($80,000 minus the $10,000 QCD minus your $24,000 SD). That’s $9,000 less taxable income than itemizing!
Regardless of your RMD amount, a QCD (up to your total RMD amount) makes sense due to the fact that the QCD reduces, dollar for dollar, the amount of the RMD that is taxable, and it does so without itemizing (meaning that you still get to take the $24,000 SD). This means QCDs from IRAs can be useful for anyone over age 59½ (when you can withdraw money with no 10% penalty for early withdrawal) who is making any charitable donations that wouldn’t be entirely tax deductible under the new tax law. However, for those over the age of 70½ who are receiving RMDs from IRAs, the argument for using QCDs is especially compelling.
Disclosure/Caveat: Viridian provides both tax and financial planning, in addition to investment management services. This summary is meant to serve as general information, and we encourage you to seek advice from your tax and financial advisors regarding if/how QCDs could help you reach your financial goals. Everyone’s situation is unique, and your complete financial picture should be considered before making such decisions.