Take Advantage of Tax Savings with Your RMD

Once taxpayers turn age 70½, required minimum distributions (RMDs) must be made annually from any non-Roth IRA accounts. These amounts are calculated each year, based on the total amount in the IRA and the taxpayer’s (and spouse’s, if applicable) ages. Over the years, Congress has passed provisions allowing for Qualified Charitable Distributions (QCDs) from these accounts; however, often the legislation was passed retroactively just before the end of the year, limiting planning and usage 100c. That has changed because part of the PATH Act of 2015 extends these provisions permanently. This is great news for charitable taxpayers with IRAs, as making use of the QCD deduction benefits taxpayers of many income levels.

How does it work?

Taxpayers age 70½ or older direct their IRA trustee to make a distribution check directly payable to the charity. The charity then must provide an acknowledgment of the gift. Then on Form 1040, the taxpayer reports the full amount of any IRA distributions on line 15a, but then subtracts any QCDs to get to the taxable amount on line 15b. If all IRA distributions are given directly to charity, the taxpayer would report zero on line 15b.

Isn’t this the same as itemizing?

No, it is not. When a taxpayer itemizes, the entire amount of the IRA distribution is included in Adjusted Gross Income (AGI), and the charitable amount is then added to Schedule A, as part of itemized deductions. Those deductions are then subtracted to arrive at taxable income only if they exceed the standard deduction amount ($15,100 for a couple in their 70s filing jointly). Including the IRA distributions in AGI can then affect the amount of Social Security income that is taxable, as well as raise the threshold needed to deduct medical and miscellaneous amounts on Schedule A. Using a QCD lowers the taxpayers’ AGI.

Part of the beauty of a QCD is that even people who don’t itemize can take advantage of it, be it people who donate thousands of dollars, or hundreds of dollars. Including charitable donations on Schedule A often does not benefit a taxpayer because itemized deductions may not exceed the standard deduction, especially once mortgages are paid off later in life and portions of the taxpayer’s retirement income is not taxable at the state level. For those whose retirement income is taxed at the state level, using a QCD may also lower state taxes, as using a QCD will directly reduce AGI.

Following is an example using 2016 tax rates for a couple in their 70s who receive a $20,000 IRA distribution, along with $50,000 in Social Security income. They donate $5,000 annually to various charities. As you can see below, using QCDs for the charitable donations instead of the taxpayers receiving the distributions and then making the donations results in federal tax savings of $1,758!

What to do next

Specific rules must be followed to allow for this preferred treatment, which include not exceeding the limit of $100,000 per taxpayer (and each taxpayer may use only his or her account to make the QCD). Gifts must be made from an individual IRA, which includes rollover IRAs, but not from a SEP or SIMPLE IRA. Qualifying charitable gifts may be made only to public charities—private foundations, donor advised funds and split interest charitable trusts are ineligible. Checks must be made payable directly to the charity; however, the taxpayer may have the check sent to him or her to then distribute to the charity personally. Finally, the taxpayer must be at least 70½ on the date of the gift, not just in the tax year in which the donation is made.

To determine if this is something that would benefit you, contact your tax advisor for more guidance on how to get the most benefit from your RMD.