|Pathways Advisory Group, Inc.|
Jeff Karst, CFP®
Want to give to charity and multiply the tax benefits for yourself? Read on… it is a bit technical though. What is a Qualified Charitable Distribution (QCD)? A QCD is a distribution directly from a Traditional IRA to a public charity that is not counted as income to the account owner (up to $100,000) and can satisfy the Required Minimum Distribution for that year. The account owner must be age 70½ or older.
The QCD has been around for a few years but Congress (until recently) continued to “kick the can down the road” by extending it only a year or two at a time. It was even retroactive some years, so taxpayers would make one hoping they would reinstate the law. With the Consolidated Appropriations Act of 2016, Congress has finally made the QCD a permanent fixture in the law.
What is the advantage to a QCD? You might think that if you take a taxable distribution and donate the money to a charity that it’s essentially a wash (if you take the deduction on Schedule A of your Tax Return). Well, it turns out that our Tax Code is really not that simple.
Taxation of Social Security
Let’s say we have a retired married couple that has a combined annual Social Security benefit of $30,000, $10,000 of portfolio dividends, and $10,000 of capital gains (selling assets to supplement income). Their combined Required Minimum Distribution is $60,000.
The IRS will tax up to 85% of your Social Security depending on your other income. In the above scenario, the taxable amount of Social Security would be $25,500 (the full 85%). Their total gross income would be $105,500. If, however, the couple decides they don’t need the RMD and would like all of it to go to charity with a QCD, the $60,000 distribution is not considered income. Under this scenario, the taxable portion of their Social Security would only be $1500 (just 5%). Now their gross income is only $21,500. Their gross income is $84,000 less!
Certain Itemized Deductions
Medical expenses can be deducted on Schedule A but are subject to a floor. That floor is 7.5% for those over 65 and 10% for those under 65 (until 2017, then it goes to 10% for everyone). For a 70 year old couple with a gross income of $105,500, they could only deduct expenses that exceed $7912 for the year. If their gross income drops to $21,500 using the QCD, then expenses above $1612 can be deducted. That’s an additional $6300 in deduction!
Miscellaneous expenses (advisor fees, accountant fees, etc.) can also be deducted but are subject to a 2% floor. Using the same numbers from above, the QCD nets the couple an additional $1680 in miscellaneous deductions.
Using the Standard Deduction
Increasing your itemized deductions is great, but what if the couple doesn’t have any deductions to take (other than the charitable contribution). With a QCD, they would reduce their itemized deductions to zero! But, for a 70 year old couple, the standard deduction (in 2016) would be $15,100. If they were still fully taxed on Social Security (at 85%) they would still reduce their taxable income by $15,100!
Means-adjusted Medicare premiums are the hidden tax. A couple with an income above $170,000 or single people with income over $85,000 pay a higher Medicare premium. See the table here on the government’s website for the details.
If the taxpayers fall into one of these brackets, a QCD may lower their income enough to receive the lower Medicare premium. That’s an annual savings between $1168 and $4677 for a married couple (depending on the size of the RMD).
With our current tax code, a QCD could benefit taxpayers who are charitably inclined. A specific tax analysis would be necessary to determine each taxpayer’s benefit.
The current process to complete a QCD is different with each custodian. Charles Schwab does not currently have a process to report the QCD. They report as a normal distribution and it’s up to the client to report it correctly on the Tax Return. Now that QCDs are permanent, we hope the process will become systematized.
Multiplying your tax benefits is a wonderful thing. You’ll be smiling all the way to your favorite charity.
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