If you are at least 70½ years old, you can make charitable distributions from your IRA directly to your favorite charity tax-free!
The Pension Protection Act of 2006 first allowed taxpayers age 70½ and older to make tax-free charitable donations directly from their IRAs. The law was originally scheduled to expire in 2007, but was extended periodically through 2014 by subsequent legislation and finally made permanent by the Protecting Americans from Tax Hikes (PATH) Act of 2015.
By making what’s called a qualified charitable distribution (QCD), you can benefit your favorite charity while excluding up to $100,000 annually from gross income.
These gifts, also known as "charitable IRA rollovers," would otherwise be taxable IRA distributions.
Beginning after 2019, if you make deductible contributions to an IRA for the year you reach age 70½ or beyond, this could reduce the allowable amount of your QCD.
How qualified charitable distributions work
In order to make a qualified charitable distribution, you simply instruct your IRA trustee to make a distribution directly from your IRA (other than SEP and SIMPLE IRAs) to a qualified charity. The distribution must be one that would otherwise be taxable to you.
You can exclude up to $100,000 of qualified charitable distributions from your gross income each year. And if you file a joint return, your spouse (if 70½ or older) can exclude an additional $100,000 of qualified charitable distributions.
You don't get to deduct qualified charitable distributions as a charitable contribution on your federal income tax return — that would be double-dipping.
Qualified charitable distributions and required minimum distributions
Qualified charitable distributions count toward satisfying any required minimum distributions (RMDs) that you would otherwise have to receive from your IRA, just as if you had received an actual distribution from the plan. However, distributions that you actually receive from your IRA (including RMDs) and subsequently transfer to a charity cannot qualify as QCD.
Assume that your required minimum distribution for 2020, which you're required to take no later than December 31, 2020, is $25,000.
- You receive a $5,000 cash distribution from your IRA in February 2020, which you then contribute to Charity A.
- In June 2020, you also make a $15,000 qualified charitable distribution to Charity A.
You must include the $5,000 cash distribution in your 2020 gross income (but you may be entitled to a charitable deduction if you itemize your deductions, a strategy that may be less beneficial now than prior to 2018 due to passage of the Tax Cuts and Jobs Act).
You exclude the $15,000 of qualified charitable distributions from your 2020 gross income. Your $5,000 cash distribution plus your $15,000 qualified charitable distribution satisfy $20,000 of your $25,000 required minimum distribution for 2020. You'll need to withdraw another $5,000 no later than December 31, 2020, to avoid a penalty.
Assume you turned 70½ in 2019.
- You must take your first required minimum distribution (for 2019) no later than April 1, 2020.
- You must take your second RMD (for 2020) no later than December 31, 2020.
Assume each required minimum distribution is $25,000. You don't take any cash distributions from your IRA in 2019 or 2020. On March 31, 2020, you make a $25,000 qualified charitable distribution to Charity B. Because the qualified charitable distribution is made prior to April 1, it satisfies your $25,000 RMD for 2019.
On December 31, 2020, you make a $75,000 qualified charitable distribution to Charity C. Because the qualified charitable distribution is made by December 31, it satisfies your $25,000 RMD for 2020. You can exclude the $100,000 of QCDs from your 2020 gross income.
Legislation passed at the end of 2019 raised the RMD age to 72 beginning January 1, 2020. If you reached age 70½ in 2019, the previous rule would have still applied: your first RMD would have been mandated by April 1, 2020. However, due to the CARES Act, required minimum distributions (RMDs) are waived in 2020.
As indicated earlier, a qualified charitable distribution must be an otherwise taxable distribution from your IRA. If you've made nondeductible contributions, then normally each distribution carries with it a pro-rata amount of taxable and nontaxable dollars. However, a special rule applies to QCDs — the pro-rata rule is ignored and your taxable dollars are treated as distributed first.
Assume you have a single traditional IRA with a current value of $100,000, which includes $10,000 of nondeductible contributions. Therefore, you have a taxable balance of $90,000 and a nontaxable balance of $10,000.
- If you were to make a $5,000 withdrawal from your IRA, 9/10s ($10,000/100,000) of your distribution, or $4,500, would be taxable and 1/10 ($10,000/100,000), or $500, would be nontaxable.
- However, if you make a $5,000 qualified charitable distribution, the entire $5,000 amount will be considered to come from your $90,000 taxable balance.
What if you have multiple IRAs?
If you have multiple IRAs, they are aggregated when calculating the taxable and nontaxable portion of a distribution from any one IRA.
Assume you have two traditional IRAs:
- IRA One has a value of $50,000 and does not include any nondeductible contributions.
- IRA Two also has a $50,000 value but includes $10,000 of nondeductible contributions.
For tax purposes, you are treated as owning a single traditional IRA with a value of $100,000 and a nontaxable balance of $10,000.
If you were to make a withdrawal of $50,000 from IRA Two, 9/10s ($10,000/100,000) of your distribution, or $45,000, would be taxable and 1/10 ($10,000/100,000), or $5,000, would be nontaxable.
However, if you make a $5,000 qualified charitable distribution from IRA Two, the entire $5,000 amount will be considered to come from your $90,000 taxable balance.
Required minimum distributions are calculated separately for each traditional IRA you own, but may be taken from any of your IRAs.
Your qualified charitable distribution cannot be made to a private foundation, donor-advised fund, or supporting organization (as described in IRC Section 509(a)(3)). Further, the gift cannot be made in exchange for a charitable gift annuity or to a charitable remainder trust.
Why are qualified charitable distributions important?
Without this special rule, taking a distribution from your IRA and donating the proceeds to a charity would be a bit more cumbersome and possibly more expensive.
- You would request a distribution from the IRA and then make the contribution to the charity yourself.
- You would include the distribution in gross income and then take a corresponding income tax deduction for the charitable contribution.
- But due to IRS limits, the additional tax from the distribution may be more than the charitable deduction.
- And due to much higher standard deduction amounts ushered in by the Tax Cuts and Jobs Act passed in 2017, itemizing deductions may have become even less beneficial in 2018 and beyond, rendering QCDs even more potentially appealing.
Qualified charitable distributions avoid all this by providing an exclusion from income for the amount paid directly from your IRA to the charity — you don't report the IRA distribution in your gross income, and you don't take a deduction for the qualified charitable distribution.
The legal and tax issues discussed here can be complex. Be sure to consult an estate planning attorney, your financial advisor and the planned giving officer at your favorite charity for further guidance.