Charitable contributions may still be claimed as an itemized deduction, but the TCJA restricted itemized deductions for state and local income and property tax, tinkered with the deduction for residence interest (by reducing the dollar limit on acquisition debt and eliminating the deduction for interest on home equity debt), and did away with miscellaneous itemized deductions. It also nearly doubled the standard deduction. The net result is that charitable contributions won't yield any tax benefit for the many millions more Americans who will no longer itemize their deductions.
But the TCJA didn't touch one way for older individuals—specifically, those who are age 70½ or older and are receiving required minimum distributions (RMDs) from IRAs—to come out ahead tax-wise when they make a charitable contribution. The key is to make annual contributions by way of qualified charitable distributions from their IRAs, and to reduce RMDs by a commensurate amount.
Required minimum distributions. Taxpayers must start taking annual RMDs from their traditional IRAs by April 1 following the year in which they attain age 70½. (Code Sec. 401(a)(9) Failure to withdraw the annual RMD could expose the taxpayer to a penalty tax equal to 50% of the excess of the amount that should have been withdrawn over the amount actually withdrawn. (Code Sec. 4974) The first distribution year is the year in which the IRA owner attains age 70½, but that first distribution may be postponed until the second distribution year.
The amount of each RMD is calculated separately for each IRA. However, the RMD amounts for the separate IRAs may be totaled and the aggregated RMD amount may be paid out from any one or more of the IRA accounts. (Reg. § 1.408-8, Q&A 9) Each year's RMD is determined by a table percentage that varies with the taxpayer's age and is applied against his or her total IRA balance at the end of the preceding year.
Qualified charitable distributions. An annual exclusion from gross income (not to exceed $100,000) is available for otherwise taxable IRA distributions that are QCDs. (Code Sec. 408(d)(8)) Such distributions aren't included in gross income, can't be claimed as a deduction on the taxpayer's return, and aren't subject to the general percentage limitations that apply for making charitable contributions. Under Notice 2007-7, 2007-1 CB 395, even though a QCD from an IRA to a charity is not included in the taxpayer's gross income, it is taken into account in determining the owner's RMD for the year.
A qualified charitable distribution is one that is made
- On or after the IRA owner attained age 70½ and
- Directly by the IRA trustee to a Code Sec. 170(b)(1)(A) charitable organization (other than a Code Sec. 509(a)(3) organization or a donor advised fund (as defined in Code Sec. 4966(d)(2)).
Also, to be excludable from gross income, the distribution must be otherwise entirely deductible as a charitable contribution deduction under Code Sec. 170 without regard to the regular charitable deduction percentage limits.
Recommendation. Using qualified charitable distributions—instead of making charitable gifts from other sources—can result in meaningful tax savings for charitable-minded older taxpayers who are receiving RMDs and will not itemize their deductions. For 2018, that will be the case if total itemized deductions, including charitable contribution deductions, won't exceed $24,000 for joint filers, $18,000 for heads of household, and $12,000 for single filers (plus $1,300 for the elderly or blind, or $1,600 for a taxpayer who is unmarried and not a surviving spouse).
Illustration. Fred and Anne Able are both age 72 and will have $110,000 of adjusted gross income (AGI) for 2018, including $40,000 of RMDs that Fred is required to take from his IRAs. They will not be able to itemize deductions. Each year, they give a $2,000 check to their place of worship and another $1,000 to a children's hospital. If they make the same gifts this year by writing checks to these charities, their taxable income will be $83,400 ($110,000 minus $26,600 standard deduction) and their federal income tax bill will be $10,227. Alternatively, they can withdraw only $37,000 from Fred's IRAs, and make their $3,000 of charitable gifts via QCDs from those IRAs. This way, they will satisfy their charitable giving goals, meet Fred's RMD requirement, and reduce their taxable income to $80,400 ($107,000 minus $26,600 standard deduction). Their tax bill will be $9,567, or $660 less than doing things the usual way.
The higher the taxpayer's marginal tax bracket, the more tax dollars would be saved. For example, if joint filers have $320,000 of non-RMD gross income and $40,000 of RMDs, making a $3,000 QCD and reducing IRA withdrawals by a like amount would save $960 (32% of $3,000) in tax dollars.
Recommendation. Taxpayers interested in using QCDs to reduce their tax bills should defer taking RMDs—or defer taking the entire amount of the RMD—until near the end of the year or whenever else in the year that they know how much they will contribute to charity for the year. By doing so, they can know before taking any actual IRA distributions how much their RMD (and AGI, and taxable income) can be reduced by making QCDs for the year.
Caution. A QCD must be made directly by the IRA trustee to a charitable organization. Thus, a distribution made to an individual, and then rolled over to a charitable organization, is not excludable from gross income.
However, if a check from an IRA is made payable to a charitable organization, and delivered by the IRA owner to that organization, then the payment to the organization is treated as a direct payment made by the IRA trustee to the organization. (Notice 2007-7, Sec. IX, Q&A 41, 2007-5 IRB 395)
Can the strategy work for itemizers as well? The answer is "yes" if the age-70½-or-older taxpayer would be able to itemize even without claiming gifts to charity, and has high medical expenses. An amount (up to $100,000) paid out to a charity as a QCD instead of being received as a regular RMD reduces AGI and may qualify the taxpayer for a higher medical expense deduction. Under the TCJA, medical expenses can be claimed as an itemized deduction for 2018 only to the extent they exceed 7.5% of AGI (above 10% of AGI for 2019 and later). Additionally, the reduced AGI may help avoid or mitigate the effect of the 3.8% surtax on net investment income. This surtax is levied on the lesser of
- Net investment income or
- The excess of modified AGI over the threshold amount ($250,000 for joint filers or surviving spouses, $125,000 for marrieds filing separately, and $200,000 for other taxpayers).