If you are 70½ or older and have tax-deferred traditional or rollover IRAs, IRS rules require you to take required minimum distributions (RMDs) each year. The RMD is taxable income. It may not only increase your tax bill, but also may push you into a higher tax bracket and may reduce your eligibility for certain tax credits and deductions. To eliminate or reduce the impact of RMD income, you may want to consider making a Qualified Charitable Distribution, or QCD.
A QCD is a direct transfer of funds from your IRA to a qualified charity such as Christ Lutheran Church. You must be 70½ or older to make a QCD, which can be counted toward satisfying your RMD for the year and is not treated as taxable income if you follow certain rules. Keeping your taxable income lower may reduce the taxes on your Social Security income and reduce the impact to certain tax credits and deductions.
The maximum annual amount that can qualify for a QCD is $100,000. This applies to the sum of QCDs made to one or more charities in a calendar year. If, however, you file taxes jointly, your spouse older than 70½ can also make a QCD from his or her own IRA within the same tax year for up to $100,000. Thus, a QCD is not only a good way to make your regular annual contributions, but also can be an advantageous way to make a major charitable gift.
For a QCD to count towards your current year’s RMD, the funds must come out of your IRA by December 31. Ask your tax advisor if making a QCD is beneficial to you. Contact your financial advisor or brokerage company to make a QCD.
Tax reporting: A QCD is reported as a normal distribution on IRS Form 1099-R for any IRA in your name. For an IRA inherited from a non-spouse, the QCD will be reported as a death distribution. Itemizing deductions on your tax return is not required to make a QCD, but you must remember to declare the amount of the QCD to be non-taxable on your tax return to get the tax-free benefit. If you itemize, you may not also claim the distribution as a charitable tax deduction.
For a better understanding of how QCDs can affect your taxable income, let’s consider a few hypothetical scenarios. Wilbur has been taking RMDs for the past few years, but this year he is considering whether to make a QCD. Wilbur did not make any non-deductible contributions to his IRA, so all his distributions will be taxable:
Scenario 1. Wilbur does not use any of his RMD as a QCD, but spends it instead: Wilbur’s RMD = $10,000. The entire $10,000 will count as taxable income.
Scenario 2. Wilbur takes a portion of his RMD as a QCD: Wilbur’s RMD = $10,000. He makes a $5,000 QCD. His remaining RMD of $5,000 will count as taxable income.
Scenario 3. Wilbur takes his entire RMD as a QCD: Wilbur’s RMD = $10,000. He makes a $10,000 QCD. He satisfies his full RMD by taking the QCD and his taxable RMD income is $0.
Scenario 4. Wilbur makes a QCD larger than his RMD. Wilbur’s RMD = $10,000. He makes a $15,000 QCD. He satisfies his full RMD and reduces his IRA balance, which will serve to reduce future years’ RMDs. His taxable RMD income is $0. Note: the additional $5,000 made as a QCD cannot count toward Wilbur’s RMD for future years.