In times of trouble, the first thing you will hear from many Americans is, “How can I help?”
By nature, they’re some of the most generous contributors among developed nations if you measure household giving as a percentage of GDP.
The response to the consequences of the Covid pandemic has been no different. Contributors range from prominent philanthropists to a single mom writing a check to a food bank.
But if you are going to make a charitable contribution, it makes sense to maximize the benefit when paying income taxes. Typically, a charitable contribution would have to be itemized on your tax return to have a tax benefit as a deduction.
It’s helpful to follow the evolution of charitable options over the past five or so years if you want to make the most of your charitable giving.
The effect of the 2017 tax reform bill
An estimated 30% of U.S. taxpayers itemized their deductions in the years leading up to the Tax Cuts and Jobs Act (TCJA) signed in late 2017. Among other measures, the TCJA increased the upper limit on charitable deductions from 50% to 60% of your adjusted gross income (AGI).
TCJA also nearly doubled the annual standard deduction while restricting or eliminating some of the valuable deductions taxpayers typically took. As a result, masses of filers took the standard deduction instead of itemizing, dropping those itemizing to 10% in 2018.
At the same time, taxpayers who benefited from the charitable contribution’s deduction fell from 21% to 9. [Source: Taxpolicycenter.org] That one change in behavior – away from itemizing – dealt a blow to charities across the nation; one of the significant side-benefits of giving had been taken away.
The Covid pandemic emerged in early 2020, amid this environment of constricted giving. Congress had to act.
The impact of the coronavirus relief bills
Enter the Coronavirus Aid Relief and Economic Security Act (CARES) of March 2020, which raised the limit for all itemized charitable contributions to 100% of AGI for the year 2020 only. It offered the possibility of wiping out a taxpayer’s entire income tax liability.
The Covid Relief Bill of December 2020 extended the CARES Act’s charitable tax incentives for the itemized cash contributions made in 2021, specifically, the upper limit of 100% of one’s AGI.
Note that these legislative changes applied only to cash contributions to qualifying public charities and not to donor-advised funds.
The ins and outs of the qualified charitable distribution
But other options already existed for generous contributors.
The qualified charitable distribution (QCD) was introduced in 2006 and authorized for one year. After that, Congress renewed or extended it repeatedly until it was made permanent in 2015. However, considering how beneficial it can be for managing one’s income tax burden, it has not been used as frequently as could be expected – maybe because of its earlier on-again-off-again status. But today, there is no reason not to explore the potential of QCDs.
Think of the QCD as a direct-from-IRA-to-charity transfer. The QCD lets taxpayers make charitable contributions directly to a qualifying charity from their IRAs with the help of their IRA’s trustee. And they don’t have to declare the withdrawal as income.
In addition, QCDs can satisfy the annual required minimum distribution (RMD) for those who have that requirement, up to a $100,000 QCD limit. And a couple filing jointly can each have a QCD and exclude up to $200,000. Anything above that is considered income, as would any other withdrawal.
(The starting age for taking RMDs was raised from 70-1/2 to 72 in 2019 as part of the SECURE Act or Setting Every Community Up for Retirement Enhancement Act. However, the QCD age was not raised to match, so there is a period in which the QCD does not offer that added advantage.)
The fact that your IRA funds are generally pre-tax makes the use of QCDs particularly attractive: you are removing taxable IRA funds from the account without tax. And because it reduces your AGI, it is more powerful than an itemized deduction. Note: you can’t also take a charitable deduction for the amount applied to your RMD, or it would be double-dipping (benefiting twice from the tax effect).
But by excluding the RMD income, the lower tax bill can bring some collateral benefits, such as lowering your Medicare Part B and D premiums or reducing or eliminating the alternative minimum tax (AMT).
For example, on Part B premiums, the government looks back to your earnings two years earlier to determine if any IRMAA surcharges are due on your premium. So, if your modified adjusted gross income for 2019 were $187,000 instead of $87,000 because you didn’t benefit from a $100,000 QCD, your premium in 2021 would be $475.20 per month instead of the base of $148.50. For a married couple, the savings would be even more significant.
However, QCDs are not available to everyone. Funds must come from IRAs, but cannot come from employer-based plans such as 401(k)s or 403(b)s. The IRA owner or beneficiary must be 70½ years old or older at the time of distribution. The $100,000 limit applies per person per year and not per IRA account. And the IRS will require a confirmation of contribution equal to what you would need to deduct a regular charitable contribution.
If you make significant charitable contributions, you can use the QCD for amounts even greater than your RMD requirement. On the other hand, if you write smaller checks to charity, you may decide to take the standard deduction and use the QCD for any amount that exceeds the standard deduction. Without a QCD, you would receive no charitable deduction at all. But with one, you also get to exclude the amount from the RMD income you declare.
Because the QCD is now permanent, you can conveniently replicate the action each year once you get it set up. (The law requires that you withdraw RMDs for the rest of your life or until the balances in your IRAs are zero.)
How else can you leverage charitable contributions?
What if you aren’t 70-1/2 yet? Or what if you want to make charitable donations from a 401(k) or another employer-based plan? Or if you want to donate more than what a QCD allows? Are there other interesting possibilities?
Yes, there are. We know that Congress increased the limit of itemized deductions to 60% of your AGI with TCJA. And to help the many charities that were hard hit by the pandemic, that limit was raised to 100% for cash donations in 2020, then extended through 2021.
As a result, you can deduct cash donations of any size, limited only by your AGI. If it comes from your IRA or employer-based plan, the withdrawal will trigger a taxable event, but contributing it to a qualified charity wipes away the tax burden. What will not be wiped away is the IRA’s 10% early withdrawal penalty if you happen to be under 59½ years old.
These withdrawals are not QCDs, so they do not have the $100,000 upper limit. But they can’t be used to satisfy RMDs either. However, there may be ways of combining the two for the greatest effect, providing unique opportunities in 2021.
Advanced strategies bring with them complexities (such as implications for other AGI-based deductions and credits) and requirements (such as withdrawal limitations on employer-based plans). But well-timed actions can bring down large IRA and 401(k) balances at no tax cost.
Such strategies become particularly appealing considering possible future tax-rate increases on retirement accounts. However, donors should always consult with their tax, legal and financial advisors when considering their charitable giving.
This article originally appeared in Old Colony Memorial.