IRA Alert

Early planning of qualified charitable distributions produces better tax results

But pay attention to the tricky tax rules to make sure clients qualify

Jan 8, 2019 @ 1:58 pm

By Ed Slott

The use of qualified charitable distributions, or QCDs, from individual retirement accounts has ballooned, but tax savings opportunities are still being lost because of some basic misunderstandings about how the QCD rules work. Plan these out early in the year to maximize the tax savings.

A QCD is a tax-efficient way to make charitable donations. It's a direct transfer from an IRA to a charity, and it's available only to IRA owners and IRA beneficiaries who are age 70½ or older. A QCD is different from a required minimum distribution, which clients must begin to take no later than the year they reach 70½. A client could take his first RMD prior to reaching age 70½, but he would not be eligible to do a QCD until he actually attains this age.

The QCD limit is large, and QCDs can be done in excess of the RMD amount. Each IRA owner is permitted up to $100,000 in QCDs annually. Spouses are allowed $100,000 each, but they cannot share the total (i.e., one spouse cannot make a $150,000 QCD if the other uses only $50,000). There is no carryover of any unused QCD allowance.

In 2018, the Tax Cuts and Jobs Act introduced a new, higher standard deduction that will be used by more filers. Some clients already missed the QCD boat for 2018, but you can help them take advantage of it now with early 2019 QCD planning. QCDs can effectively add to the standard deduction (or existing charitable deduction, if clients are still itemizing) by allowing direct donations made from IRAs to be excluded from income, thus lowering adjusted gross income — and the tax bill.

If your client meets the QCD eligibility rules, it is essential that you address QCDs early in the year, before any RMDs are taken. This will reduce the possibility of the QCD opportunity being lost or causing RMDs to be taxed as a result of poor timing.

(More: A younger spouse can lower required minimum distributions)

First-dollars-out rule

Once an IRA is subject to RMDs, the first dollars withdrawn during the year are deemed to count toward satisfying the RMD. One of the key benefits of the QCD is that it can count toward satisfying the RMD, thereby excluding that income from taxation. But once the RMD is taken, a future QCD cannot offset that income.

For example, John is 75, takes his full RMD in February and deposits the funds into his bank account. In November, he wants to do a QCD. John cannot retroactively deem the February distribution to be a QCD. He must take an additional distribution if he still wishes to do a QCD for that calendar year. That income can be excluded, but that still won't offset the income from the RMD taken earlier in the year.

This is why advisers should identify all clients who might be eligible for a QCD and contact them before they take any RMDs. Explain how using the QCD for the first IRA dollars withdrawn can count toward the RMD and exclude that income from taxation.

However, for first-time RMD clients, early QCDs may be a challenge, depending on when they actually turn age 70½. Remember that the QCD cannot be used until the IRA owner is actually 70½ years old.

For example, if your client will turn 70½ at the end of December, the QCD cannot be taken until then. The client may have to move fast to have it count for 2019, but this haste should affect only the first QCD. The client can complete subsequent QCDs early in those years.

Here's another planning point for first-time RMD clients, those who will turn age 70½ in 2019. If an IRA owner turns age 70½ in 2019, the required beginning date for the first RMD is not until April 1, 2020. But if the owner waits until 2020 to take the first RMD, not only must he or she take the first two RMDs in 2020, but the QCD option will be lost for 2019 because no IRA funds were withdrawn in 2019. A 2019 QCD cannot be used to offset the RMD income if that 2019 RMD is taken in early 2020.

(More: Can inherited IRAs be split in a divorce?)

Ed Slott, a certified public accountant, created Ed Slott's 2-Day IRA Workshop and Ed Slott's Elite IRA Advisor Group. For more information, visit www.IRAhelp.com.

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