At least there is something good about growing old from a tax perspective. Under a unique tax law provision, certain senior citizens can transfer a sizeable amount of funds directly from an IRA to a qualified charitable organization without paying any tax on the distribution. Significantly, this “qualified charitable distribution” (QCD) also counts as a required minimum distribution (RMD) for tax purposes.
The QCD provision (sometimes called a “charitable rollover”) has expired and been reinstated a few times in the past. Currently, thanks to the Protecting Americans from Tax Hikes (PATH) Act of 2015, it is a permanent part of the tax code.
Background: Previously, you could not directly transfer funds tax-free from an IRA to a charitable organization. Instead, you were required to pay tax on the distribution, regardless of your charitable intentions. This arrangement worked against retirees who wanted to use IRA funds for charitable donations but no longer itemized their deductions.
However, beginning with the Pension Protection Act of 2006 (PPA) and extended by subsequent legislation, individuals who are age 70½ and older can transfer IRA funds directly to a charity, up to an annual limit of $100,000 ($200,000 for a married couple).
Although no tax deduction is allowed, donors are not taxed on the distribution either. It is essentially a “wash” in the eyes of the IRS.
For these purposes, a qualified distribution is defined as one coming from either a traditional IRA or Roth IRA that would otherwise be taxable. The distribution must be made directly from the IRA trustee to the charity.
Furthermore, the contribution must otherwise qualify as a charitable donation. If the deductible amount decreases because of a benefit received in return—for a dinner at a fundraising event, for example—or the deduction would not be allowed due to inadequate substantiation, the exclusion is not available for any part of the IRA distribution.
Under a special rule for charitable donations, the IRS treats distributions from an IRA funded at least partially with nondeductible contributions as coming first from taxable funds and then from nontaxable funds. All of the individual’s IRAs are grouped together for this calculation.
Finally, an IRA participant is generally required to begin receiving RMDs in the year after the year in which he or she turns age 70½. A QCD is treated as a distribution that can fulfill this requirement.
Note that similar rules may apply to Roth IRAs. Roth IRA distributions to individuals older than age 59½ are often tax-free. But a portion of a distribution may be taxable for a Roth in existence less than five years. If you have both a traditional IRA and a Roth IRA, it generally makes sense to use the traditional IRA first for charitable distributions.
Be aware that the QCD technique is not for everyone. However, it can come in quite handy at this time of the year if you still have to take RMDs. If this piques your interest, obtain JMF professional guidance as to how it might affect your family’s situation.