Q.: Hi Dan,
You have mentioned donating from an IRA in several of your columns. It is clear you are a fan of donating this way. Is it really that much better than just writing a check?
—PK in Tampa
I am indeed a fan of Qualified Charitable Distributions (QCD) and QCD beat cutting a check most of the time. Giving from an IRA is one of the most effective ways to give and save taxes for most people that are eligible to make a QCD. Any amount you donate is not counted as income. This helps reduce tax liability in several ways, some significant and some subtle.
Before I get to the advantages, I want to mention a few important limitations. First, the IRA owner must be older than 70 ½ on the date of the distribution. Second, the distribution check must be paid directly to a 501c3 public charity. This doesn’t work if the funds are sent to a private foundation or a donor-advised fund. Last, QCD can only be made from a traditional IRA account, inactive SEP-IRA or inactive SIMPLE-IRA and the total of all QCD from one individual cannot exceed $100,000 for the year.
The first significant advantage of donating through QCD comes to any eligible taxpayer that is subject to Required Minimum Distribution (RMD) and older than 70 ½. (Beneficiaries of inherited IRAs that are not yet 70 ½ are not eligible.) The QCD counts toward the RMD.
Say a couple both 72 have total RMD from their IRAs of $50,000. If they donate $10,000 to their church, they will receive a 1099-R for $50,000 and report that on line 4a of their tax return. However, they will only report $40,000 as taxable on line 4b. None of the $10,000 donated counts as part of their income.
If they had written a check for $10,000, they would report $50,000 as taxable on line 4b and listed $10,000 on their Schedule A – Itemized Deductions. However, they may not get a full deduction for their donation. In fact they may not get any tax benefit from having written that check.
Say our couple have a 2021 Schedule A that lists $5,000 of deductible medical expenses and $7,000 of state and local taxes before making the donation. That makes the total of their itemized deductions $12,000. The standard deduction for the couple is $27,800. Therefore, they would use the standard deduction and report $50,000 of taxable income on line 4b if they did not make a donation.
By making the donation, their itemized deductions would only total $22,000 so they would still use the standard deduction and report $50,000 of taxable income on line 4b. Thus, no tax benefit all. In fact, in this example the first $15,800 ($27,800-$12,000) of donations provide no additional tax benefit. By donating the $10,000 as a QCD, the full $10,000 comes off the taxable income on their return.
The tax benefit of making the donation via QCD has other benefits over writing a check. Many other tax items are tied to Adjusted Gross Income. For instance, as income reported causes Adjusted Gross Income (AGI) to rise, more of one’s Social Security can become taxable, capital gains can be taxed at a higher rate, Medicare premiums can increase, taxes on Net Investment Income can be triggered, and the amount of medical expenses that can be deducted drops just to name a few effects of higher gross income.
By using QCD, all of these effects are avoided because the income from the distribution never shows up as taxable income on the 1040. Just remember to communicate the QCD made to your tax preparer. If you don’t tell them, they won’t know to omit the QCD from line 4b. It’s a very common filing error.
If you have a question for Dan, please email him with “MarketWatch Q&A” on the subject line. Dan Moisand is a financial planner at Moisand Fitzgerald Tamayo serving clients nationwide from offices in Orlando, Melbourne, and Tampa, Florida. His comments are for informational purposes only and are not a substitute for personalized advice. Consult your adviser about what is best for you. Some questions are edited for brevity.