Year-end QCD mistakes to avoid

The great tax benefits of qualified charitable distributions can be forfeited if the rules aren't followed.

Assets in individual retirement accounts are the best assets to give to charity, since they’re loaded with taxes. For those who give regardless, using IRAs to make the gifts can provide tax benefits — but only if it’s done correctly. If not, the tax benefits can be lost.

Qualified charitable distributions are one of the best ways for IRA owners to receive tax benefits for their donations. QCDs are done by making a direct transfer from the IRA to a qualifying charity. The tax benefit is that the distribution from the IRA is not included in income, where it otherwise would be.

The only downside to QCDs is that they’re not available to everyone. Only IRA owners and beneficiaries who are age 70½ or older qualify. QCDs can’t be done from 401(k)s.

The annual QCD limit is $100,000 per IRA owner, not per IRA account. Properly timed QCDs can also offset required minimum distribution income. Even though the RMD age is now 73, the QCD age has not changed, so QCDs can be done even before RMDs begin.

Most people no longer receive tax benefits for their charitable gifts since more than 90% of taxpayers don’t itemize their deductions. Instead, they use the higher standard deduction, which in 2023, for IRA owners aged 65 or over, is $30,700 for a married couple filing jointly and $15,700 for single individuals. A QCD provides a tax benefit even for people who take the standard deduction because it doesn’t count as adjustable gross income.

These great tax benefits, however, can be forfeited if the QCD rules aren’t followed. Not surprisingly, that seems to happen more frequently at year-end, when advisors and clients are up against deadlines. Here are the most important QCD pitfalls:

QCD TIMING ERRORS

One of the key benefits of using QCDs is that the distribution from the IRA to the charity isn’t included in income and can satisfy the RMD amount. However, if an RMD was already taken earlier in the year, a QCD taken subsequently can’t offset the RMD income. The QCD will still be excluded from income, but the RMD already taken will be included in income. To avoid that result, make sure to do the QCD first, before taking the RMD.

WAITING UNTIL RMDs BEGIN

Some IRA owners think they can’t do QCDs until RMDs begin. The QCD age is still age 70½ even though the RMD age has been raised to age 73. Missing out on the few years before RMDs begin can mean lost tax benefits for donations that are being made anyway.

BEWARE OF IRA DEDUCTIONS

An IRA deduction can invalidate the QCD tax benefit. This became an issue when the original SECURE Act removed the restriction against making traditional IRA contributions after age 70½.

Taking an IRA deduction in the same year as doing a QCD could cause the QCD to be included in income. For example, if a person made a 2023 deductible IRA contribution of $7,500 and also did a $10,000 QCD, only $2,500 of that QCD would be excluded from income. The remaining $7,500 would be a taxable QCD, eliminating the tax benefit. Any amount of QCD not allowed can still be taken as an itemized deduction. However, since most people no longer qualify for itemizing, the QCD tax benefit would be lost. (In certain cases, a deductible IRA can also make a subsequent year’s QCD taxable.)

The better option for those who wish to use the QCD is to not make a tax-deductible IRA contribution. Instead, contribute to a Roth IRA. If income is above the Roth IRA contribution limits, use the back-door Roth IRA, where a contribution is made to a nondeductible traditional IRA and then converted to a Roth IRA.

QCDs VIA CHECKBOOK IRAs

QCDs that are desired for this year must be completed by year-end. The funds must leave the IRA and go to the charity on or before Dec. 31. In cases in which IRA owners make the QCD gifts using “checkbook IRAs,” those checks must clear by year-end. If they’re not cashed by the charity, they won’t show up as a distribution for this year for tax reporting purposes.

BENEFICIARY QCDs

IRA beneficiaries qualify to use QCDs, but they must also be age 70½ or older. The fact that the deceased IRA owner was over age 70½ at death has no bearing on this. If a beneficiary attempts a QCD before reaching age 70½, it won’t qualify and won’t be excluded from income. In addition, even for qualifying beneficiaries (those 70½ or older), the QCD ordering rules still apply. If the IRA beneficiary is subject to RMDs, the QCD must be done before taking the RMD; otherwise, the QCD won’t offset the RMD income.

BENEFITS BACK TO THE IRA OWNER

By law, the QCD will only qualify if “a deduction for the entire distribution would be allowable” if made as an itemized deduction, according to Tax Code Section 408(d)(8)(C). You don’t have to itemize deductions to qualify for the QCD benefit. But the entire amount of the gift would have had to be deductible if you had itemized. This means there can be no benefit back to the donor, like tickets to a show, dinners, discounts, etc., other than certain intangible benefits or titles. Any benefit received back would void the entire QCD benefit, not just the amount of the benefit. Make sure you receive a contemporaneous written acknowledgement, or CWA, from the charity indicating that you didn’t receive any benefit in return.

A QCD can be a game-changer of a tax benefit. Don’t mess it up by failing to follow the playbook.

For more information on Ed Slott and Ed Slott’s 2-Day IRA Workshop, please visit www.IRAhelp.com