I’m a big fan of qualified charitable distributions (QCDs). The now permanent law allows IRA holders who are over 70 ½ to make distributions from their IRA directly to a charity. There are two primary benefits to using this strategy:
- The IRA owner does not have to claim the QCD as income. The avoidance of taxable income offers a host of potential benefits including a possible reduction in Social Security taxes, Medicare premiums and avoidance of higher tax brackets.
Example: Tom withdrew $10,000 from his IRA as a distribution payable to the Red Cross. Tom will not have to pay taxes on the $10,000. His income from IRAs as reported on his tax return will be $10,000 less than it would have been otherwise.
2. The amount of the QCD counts towards the required minimum distribution (RMD) for the year. I don’t like using two acronyms in the same sentence so I’ll explain in English: The amount withdrawn from the retirement account and given directly to charity counts towards the amount the individual is required to withdraw for the year.
Example: The IRS required Tom to withdraw $65,600 from his IRA in 2019. Tom elected to direct $10,000 directly to the Red Cross. He now only has to withdraw $55,600 for himself. Only the $55,600 distribution is taxable. The $10,000 given to charity is not taxable as income.
But as much as I love QCDs, the tax reporting leaves something to be desired. Let me address the two items that create confusion.
First, taxpayers must know that QCDs are treated differently than other charitable contributions.
For example, let’s assume Tom wrote a $1,000 check to his church at Christmas. That’s a charitable donation of cash that would be reported on Schedule A (Itemized Deductions). If Tom itemizes his deductions (a big “if” given the increased standard deduction) then Tom will able to reduce his income by the amount of his charitable donation. Note that if Tom doesn’t itemzie his deductions, there will be no tax benefit for his generous Christmas donation. This further highlights the value of making charitable gifts directly from an IRA.
Also note that QCDs are not deductions from income. As discussed above, QCDs are excluded from income. Because QCDs are excluded from income they should not also be included as a charitable deduction on Schedule A.
In sum, if you make both QCDs out of your IRA and cash donations, you’ll need to separate the two.
Second, taxpayers must be aware of how QCDs are reported on 1099-Rs.
In our example above, Tom was required by the IRS to distribute $65,600 from his IRA in 2019. His custodian (Schwab) mailed him a 1099-R showing the gross distribution.
Please note that while box 2a says “taxable amount,” that should not be taken literally. In the instructions the IRS clarifies that the amount in box 2a is generally taxable, not always taxable. The X in box 2b confirms that the custodian (Schwab) is not able to determine the taxable amount of this distribution.
The custodian is required to report the amount of the gross distribution ($65,600). It is the taxpayer’s responsibility to inform the IRS that $10,000 was given to the Red Cross. As a result, while the amount in 2b ($65,600) may generally be taxable, in this case it is not. The taxable amount is actually $55,600.
The tax reporting would be as follows:
Line 4a (of the 1040-SR) shows the gross distribution from the IRA as reported by the custodian. The taxable amount is reduced by the amount given directly to charity. “QCD” in the margin indicates the qualified distribution to charity that is not taxable.
If this has not been reported correctly on prior year returns, contact your tax advisor to file an amended return before the statute of limitations expires.
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