Qualified Charitable Distributions - What they are and how they provide valuable tax savings. [a detailed review]
A qualified charitable distributions are donations to an eligible charity taken directly from your traditional IRA. Depending on the amount you give to qualified charitable organizations annually, the tax savings of having the payments made directly from your traditional IRA can be huge! If you are 72 years old or older (or 70½ years old, if you reached 70½ before January 1, 2020), you need to take required minimum distributions (RMDs) from your traditional IRA. Setting up the donations to your favorite charity to come directly from your traditional IRA rather than writing a check can save you some serious money come tax time. Tax planning now can reap huge rewards for when you file your taxes next year for this year!
How to Qualify for Qualified Charitable Distributions
IRA owners need to take required minimum distributions (RMDs) from traditional IRAs when they reach 72 years old or older (or 70½ years old, if you reached 70½ before January 1, 2020). These required minimum distributions are taxed at ordinary income rates. This means the tax bracket that applies to your taxable income that year will apply to the distributions you are required to take from your traditional IRAs. Taxpayers are not required to take required minimum distributions from their Roth IRAs, because the money used to fund Roth IRAs has already been taxed.
If you fail to take your required minimum distribution, the IRS punishes you in a big way! The penalty: a 50% excise tax penalty! Yikes, 50%!
If you normally donate to an eligible charitable organization or if you are required to take the RMD and don’t really need the money, qualified charitable distributions provide a great way to meet your RMD, while avoiding the 50% excise tax penalty and saving on your ordinary income taxes.
Example: Bruce needs to take a required minimum distribution (RMD) of $150 every month from his traditional IRA. He files married filing jointly and takes the standard deduction because his spouse and him do not have enough deductions to itemize. He supports a local food pantry that is an eligible nonprofit by donating $100 each month or $1,200 annually.
In the example above, because Bruce does not have enough deductions to take the itemized deduction, if he makes the donations to the food pantry directly from his checking account, he would receive no tax benefits. None! However, if Bruce was to set up a qualified charitable distribution from his traditional IRA, he would not have to pay federal income tax on the $1,200 he donates to the food pantry. A huge win! If Bruce’s tax bracket is 24%, this would save him $288 ($1,200 x 24%) in federal income taxes. If Bruce did not want to pocket the tax savings, he could donate almost $1,500 to the food pantry using a qualified charitable distribution that would cost him almost the same amount as donating $1,200 using funds from his checking account. A win for both Bruce and the food pantry!
The great thing about qualified charitable distributions is you do not need to itemize your deductions to get the tax benefits. As long as you set up the qualified charitable distributions to come directly from your IRA through your IRA custodian, you do not have to pay taxes on the amount given to an eligible charity. Sometimes, being charitable does pay!
Eligible Charity Organizations
The majority of charitable organizations qualify as eligible charities. Eligible charities are 501(3)(b) organizations and churches. Although you cannot just give the money to a family member or friend, there are many organizations that qualify. If you donate or want to donate to a charity, you can confirm if they’re eligible by looking them up on the IRS website here: https://www.irs.gov/charities-non-profits/tax-exempt-organization-search.
Lower Your Adjusted Gross Income
If you need to take a required minimum distribution from your traditional IRA, qualified charitable distributions can be a great way to lower your adjusted gross income. With some careful tax planning, this can help you keep your taxable income in a lower tax bracket or prevent your income from reaching the net investment income tax threshold for higher wage earners. This is because qualified charitable distributions are not counted on your tax return as taxable income.
The Bottom Line
Qualified Charitable Distributions for qualified traditional IRAs to eligible charities can provide a great way for taxpayers age 72 years old or older (or 70½ years old and older, if you reached 70½ before January 1, 2020) to both 1) meet required minimum distribution requirements from traditional IRAs; and 2) not to have to pay federal income taxes on distributions from their traditional IRAs. This works great for taxpayers, who do not have enough deductions to take the itemized deduction and/or regularly give to an eligible charity, such as a food bank, church, or other eligible nonprofit.
If you are not sure how setting up a qualified charitable distribution would affect your taxable income, contact the tax professionals at Gudorf Tax Group to schedule an appointment to review how setting up a qualified charitable distribution from your traditional IRA could lower your tax liability.