Tax Saving Strategy for the Charitably Inclined
As the US Government persists in finding new ways to increase tax revenue, taxpayers must continue to look for legitimate options to reduce their tax liability both now and in the future. Tax reduction strategies are often focused on delaying the payment of tax into future years so that your current investments can continue to grow prior to being taxed, but an even better tax savings can be achieved when the IRS regulations allow certain income to avoid taxation all together. For taxpayers over the age of 70½ who are charitably inclined, Qualified Charitable Distributions can lead to significant tax savings. If you or someone you know fits this description, the information below could end up being the best tax advice you receive all year.
What are Qualified Charitable Distributions (QCDs)?
Under the IRS tax code, individuals who are older than 70½ must take Required Minimum Distributions (RMDs) from their pre-tax IRAs, whether or not they need the cash to pay for living expenses. These distributions are treated as income on the recipient’s tax return, which in turn increases taxes owed and potentially impacts other tax and deduction calculations that are based on Adjusted Gross Income (AGI) and Taxable Income.
In 2006, the Pension Protection Act stipulated that those over age 70½ could make a donation of up to $100,000 directly from their IRA to a charitable organization, and avoid any taxation on the distribution. Additionally, these direct distributions help satisfy the RMD requirements in the year that they’re made. While these donations cannot be claimed as itemized deductions on the taxpayer’s return, the ability to reduce taxable income is generally equal to or better than the option to increase itemized deductions.
The following rules apply:
- The taxpayer must be 70½ years or older.
- The distribution must be issued directly to a qualified charity.
- The distribution must come from an IRA (distributions from SEPs or Simple IRAs are not eligible. Roth IRAs do not require RMDs and are not included in taxable income).
- The QCD portion of the distribution is limited to $100,000 per taxpayer.
- The distribution must be made during the calendar year.
- The distribution cannot be claimed as an itemized deduction.
How are QCDs Superior to Itemized Deductions for Donations?
As an example, let’s assume that a married couple who are both over age 70½ have about $100,000 of Adjusted Gross Income that is made up of pension distributions, the RMDs from their IRAs, and the taxable portion of their Social Security. If this couple chose to make $10,000 of QCDs from their IRAs to their favorite qualified charity, rather than paying the $10,000 out of another account and itemizing their return, they could potentially save over $2,000 in taxes. That’s not a deferral of taxes, it’s a real tax savings in the current year achieved through a little bit of careful planning.
Since your circumstances are unique, it’s important that you work with your Financial Advisor and CPA to determine the tax savings that you could personally gain from the use of QCDs. If you’d like to learn more about how the advisors at HFG Trust can work with your CPA to take advantage of this and other tax reductions strategies through our wealth management and planning services, please don’t hesitate to give us a call.