Qualified Charitable Distributions (QCD) from IRAs

“Qualified Charitable Distributions (QCDs) from IRAs,” that is the subject of today’s ACTEC Trust and Estate Talk.

Transcript/Show Notes

This is ACTEC Fellow Margaret Van Houten from West Des Moines, Iowa.

Introduction to Qualified Charitable Distributions (QCDs)

Financial professionals, tax advisors, and estate planners should understand qualified charitable distributions in depth to help clients maximize tax efficiency and charitable giving.

ACTEC Fellow Professor Christopher R. Hoyt from Kansas City, Missouri, is with us today to explain the key takeaways of QCDs and to help ensure the continued effectiveness of this tax-efficient way for individuals aged 70½ or older to process gifts to qualified charities. Welcome, Chris.

Professor Hoyt:  Thank you, Margaret. It’s great to be with you and as we do our planning here to save taxes.

Why Use Retirement Accounts for Charitable Giving

For a lot of us, the largest asset that we have is our retirement accounts. I did look at my 401k recently, which has turned into a 201k, but short of that, if I’m looking for anything to make a charitable gift with, I might want to use my retirement account. But really, your retirement account is the worst asset to use for most of your life, especially before age 59½, because a distribution would be taxable income.

But the key point to remember is that after the age of 70½, an IRA- an Individual Retirement Account- is the best asset to use for all of your charitable gifts. Don’t make gifts with cash, stock. Make your gifts from your IRA.

General Tax Rules for IRA Distributions

So by way of background, the general rule is every distribution from a retirement account will be taxed to you. If, for example, I have a $1,000 distribution to my brother in Wisconsin and a $3,000 distribution to a charity, $4,000 has left my account. I didn’t get a penny. But the IRA administrator at the end of the year will tell me that I have $4,000 of taxable income. And I say, how come? Because I didn’t get any of the money- went to my brother, went to a charity- and they said, well, what happened is every distribution from retirement account is taxed to you because income is taxed to the person who earned it. We don’t care who gets the checks.

So that’s the rule. And if I’m under the age of 59 and a half, I’ll have a 10% penalty.

What Makes a Qualified Charitable Distribution (QCD) Unique

But Congress created an exception for people over the age of 70½. It’s called a Qualified Charitable Distribution. And so, in that case, if $1,000 goes to my brother and $3,000 goes to charity, I will only have taxable income with $1,000 that went to my brother. I will not have to report as income, the $3,000 that went to the charity.

Now, I will not be entitled to an itemized charitable deduction of $3,000. But in general, reducing your gross income produces more tax benefits than getting an itemized deduction for charitable gifts.

So what happens is I get this form at the end of the year, the 1099-R, and it says you have $4,000 of taxable income. I said, but you know that $3,000 went to the charity. But that’s okay, we don’t put any burden on the IRA administrators. They just issue this form. You have taxable income $4,000. The IRA owner has a responsibility to save the taxes on their own tax return.

Reporting QCDs on a Tax Return

So, for the lines for IRA distributions, there are two boxes. One box says, “total distributions”, the second box says, “taxable distributions.” So, in the first box, I put down $4,000, which matches the number that I got on my 1099-R. But for taxable distributions, I would just put in $1,000. And I put three letters next to it; the three letters are QCD. That tells the IRS why I’m not paying tax on all $4,000. I’m just paying tax on the $1,000 that went to my brother.

To qualify, the IRA owner has to be over the age of 70½. If I do this at age 68, I got $4,000 taxable income. The most you can exclude from your income in 2025 is $108,000. It’s indexed for inflation. But the secret sauce here is that these IRA charitable gifts satisfy the Required Minimum Distribution (RMD) requirements from IRAs. And as most of you know, once you’re 73 years old, you have to start taking distributions every year from your IRA. And maybe I have to take out $4,000.

What You Cannot Do with Required Minimum Distribution (RMD)

Now there’s some things that most people cannot do with that RMD. The first $4,000 out of your IRA cannot be rolled over to another IRA. The first $4,000, the first RMD, if my RMD is $4,000, cannot be used for Roth conversion. The only thing you can do with your requirement distribution is give it to charity. And so, if my RMD was $4,000, I cut my taxable income down to just $1,000.

So, it’s kind of a pain to go to the IRA administrator and say, cut a check to charity for $3,000; my brother $1,000. Who should do it? You should only do it if you save taxes.

Who Benefits Most from QCDs

And so, the people who win with this law are donors who take the standard deduction. The charitable deduction is an itemized deduction. Unless you itemize, you can’t deduct your charitable gifts. So really senior citizens with IRAs have it better than most people because only about 9% of taxpayers are itemized.

The other people are people who live in states where the state income tax laws don’t permit a charitable deduction, such as Ohio, Massachusetts, where you can deduct it in your federal return, but you can’t deduct on a state return.

Other people who benefit are people who benefit if their income stays lower, like Medicare B premiums. If your income is over $100,000, just by $1, your Medicare B premiums go by 40%. Married joints like $200,000. So, by keeping your income lower, you can pay lower Medicare B premiums.

And finally, the people who really will recommend this are the kids, because if they have a choice between inheriting an IRA or inheriting stock, when they inherit an IRA, the distributions are taxable. But when they inherit stock, there’s no income tax on the inheritance of stock, and the stock gets a step up in basis. So, they’ll say, parents, make your charitable gifts with the IRA. So, there’ll be more stock for us to inherit and less taxable income.

Legal Requirements for QCDs

There are six legal requirements to qualify.

1. First one is you have to be over the age of 70½.
2. The second is that this only applies to individual retirement accounts. So, if you have a professor with a 403(b) or a worker with a 401(k), they can’t do this. They need to roll over some money to an IRA to take advantage of it.
3. Third, there’s a dollar limit of how much you can exclude from your income each year against $108,000 in 2025.
4. Now, one requirement is that the distribution from the IRA must be made directly from the IRA to the charity. And what that means is that the charity’s name has to be on the IRA check.

Additional Tips Regarding IRA a Checkbook

And so, the best way to get this done is most IRA administrators will issue to your IRA clients an IRA checkbook. Once at the age of 70½ or 59½ or something like that, they’ll give you an IRA checkbook. And every check you write is a taxable distribution from your IRA. Dangerous things, but they’re perfect for these charitable gifts because, you know, when the charities send their thank you letters, thank you for your gift, they might not say this was a gift from your IRA. And when you take those thank you letters to the CPA to do the tax return, they don’t know what’s an IRA gift. But if you have an IRA checkbook, then you give them a check register and then they can look at that and make sure you get the benefit from all the gifts.

I do want to warn you a little bit about IRA checkbooks. The IRA distributions are determined by when the IRA administrator issues the payment from the IRA account. With an IRA checkbook, they won’t know that until they receive the check. So, people who have not taken out the required minimum distributions, one of the big mistakes they make is they give checks to their kids and grandkids in December. And if they’re like my kids or grandkids are like me when I was a kid, they don’t cash those checks right away. So be sure you take out your requirement distributions earlier in the year and don’t wait till December.

5. The fifth requirement is that most charities qualify except for three that are the most fun. And the three that you cannot use this IRA exclusion for are a Donor Advised Fund (DAF), your grant making private foundation, or a supporting organization — a 509(a)(3), “friends of the hospital”, and the like.
6. Next requirement is that you can’t get anything back with one exception I’m going to share with you at the end where the charity can make a big gift back to you. But to qualify for this, you can’t use it for an event where you get a dinner or you’re buying something at an auction. It has to make a complete gift. I’m making a complete charitable gift.
7. And then the last requirement is the donor has to have a letter from the charity that the donor received no goods or services in exchange for the gift.

Those are the requirements.

Documentation and Pledge Payments

Some technical things, you could pay a legally binding pledge with your IRA. You can’t do that with your private foundation, but you can do with the IRA.

On a joint return, each spouse can take up to $108,000 from each spouse’s IRA. And with IRA distributions, they have a default 10% withholding tax. You just say, don’t do any withholding.

Gifting With an Inherited IRA

Last one is if you inherit an IRA, can you use your inherited IRA to make these charitable gifts? And the IRS says that if you are a beneficiary of an inherited IRA and you, the beneficiary, are over the age of 70½, you can make charitable gifts from the inherited IRA. But if you’re 50s, 60s, you can’t do that with inherited IRA.

The New Lifetime Annuity Option

The last thing to leave you with is that since 2023, charities can now give you back one major thing. And you can make a once-in-a-lifetime transfer to a charity up to $54,000 from your IRA and you can get back a lifetime annuity. Many large charities and universities issue what are called Charitable Gift Annuities.

If you’re in your 70s, they might pay you like 7% a year for the rest of your life. You can do this right now. It’s only a once-in-a-lifetime option. The maximum you can do is $54,000. But if you’re making a gift to a university, the odds are they offer these gift annuities, and you can get a lifetime income stream for you and your spouse or your spouse. And that’s it. It’s a wonderful law.

Final Tips

Again, for your clients who are in their 70s, 80s, and 90s, do not make charitable gifts with stock or mutual funds or even real estate if they have IRAs. When the kids inherit the IRA, they got taxable income. When the kids inherit the stock, mutual funds, and real estate, they get a step-up in basis. And that’s the way to do it.

Margaret Van Houten:  Thank you, Chris, for that very informative presentation.

You may also be interested in:

• Charitable Giving Tips & Tricks (video to share with your clients)
• Charitable Planning and the SECURE Act – SECURE Act Special (May 2020)

 

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