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One of the most common questions taxpayers have is “when to use qualified charitable distributions (QCDs) instead of donations in kind”. While there are advantages and disadvantages to both methods, ultimately it comes down to reducing taxes. In this article, we will explain both and the best ways to maximize your tax savings. We will talk about bunching your itemized deductions, using donor advised funds, and how that works. In the end, we will explain the best giving method.
The Qualified Charitable Distribution (QCD) – How, When and Why Retirees Should Use It
As a retiree, chances are you are looking for ways to minimize your taxes. Enter the qualified charitable distribution, or QCD. A QCD is a direct transfer of funds from your IRA custodian to a qualifying charity. This type of distribution can be very beneficial because it allows you to satisfy your required minimum distribution (RMD) while also getting a tax deduction for the charitable contribution. Let’s take a closer look at how this works.
How Does a QCD Work?
A QCD can be made from a traditional IRA or Roth IRA. The distribution must go directly from the IRA custodian to the qualifying charity – you cannot receive the distribution first and then give it to the charity yourself. The distribution must also be for at least $250.
There is no limit on the number of QCDs you can make in a year; the total amount can be more than your RMD for that year. For example, if your RMD is $24,000, you could do four QCDs of $8,000 each totaling 32,000. The excess contribution to a charity cannot be carried over into future years to cover RMDs in the future.
When Can I Start Making QCDs?
You can start making QCDs as soon as you turn age 70 ½. At 72 ½ you are required to take an RMD from your traditional IRA (Roth IRAs are not subject to RMD rules). You can continue to make QCDs in any year when you have an RMD, even if you have already satisfied your RMD for the year with other distributions. Keep in mind that the deadline for making a QCD is December 31st – distributions made after this date will not count towards your RMD for that year.
How Do QCDs Help With Taxes?
One of the biggest benefits of doing a QCD is that it can help lower your taxable income because the amount of the distribution is not included in your gross income. This is different from a regular withdrawal from your IRA, which is included in gross income and may be subject to income tax.
This can be especially beneficial if you are charitably inclined and do not itemize deductions on your tax return – by doing a QCD, you can get the benefit of a charitable deduction without having to itemize.
Another way QCDs can help lower your taxes is if you are subject to the Medicare high-income surcharge – by doing a QCD, you can lower your adjusted gross income (AGI) which may help you avoid this surcharge.
A QCD is reported on an IRS 1099-R form. It will be coded as a normal distribution for any non-inherited IRAs. For an inherited IRA it is coded as a death distribution. If you are doing the taxes yourself you must tell the software that you made a QCD to a charity and the portion of your IRA distributions that went
to a charity will be excluded from your income. If you are using a tax preparer make sure to let them know you made a QCD so you get the tax benefit of reducing your taxable income.
Is there a limit to the QCD?
Yes donors can make a QCD up to 100,000 in one year. If you are married, you may give 100,000 and your spouse may give 100,000. The Qualified Charitable Distribution can be beneficial for retirees who are
looking to minimize their taxes. If you are age 70 ½ or older and have an RMD from a traditional IRA, consider doing a QCD to satisfy all or part of that RMD while also getting a deduction for the charitable contribution. Just remember that the deadline for making a QCD is December 31st – so don’t delay!
What is a donation in kind?
When deciding how to best donate money to charity, many people choose to simply write a check. However, there can be significant benefits to donating assets instead of cash. For one thing, donating appreciated assets can help you avoid capital gains taxes. In addition, it can be easier to track your donations if you donate assets directly to charity. This is because you will receive a statement from the charity detailing the fair market value of the asset on the date of the donation.
Donations of property, or "in kind" donations, can be a great way to support your favorite charity while also getting a tax deduction. However, there are some important things to keep in mind when making an in kind donation.
First, you can only deduct the fair market value of the property. This means that if you donate appreciated property, such as stock or real estate, you will only be able to deduct the value of the property at the time of the donation if you held it for more than a year. Otherwise, you will only be able to deduct the purchase amount and not the appreciated amount. Second, you will need to itemize your deductions in order to claim a deduction for an in kind donation. Finally, be sure to get a receipt from the charity for your donation so that you have documentation in case of an audit.
When you donate stock to charity, you avoid paying capital gains tax on the appreciation in value of the stock. For example, let's say you bought stock for $1,000 that is now worth $10,000. If you sell the stock, you'll have to pay capital gains tax on your $9,000 profit. However, if you donate the stock to charity, you won't have to pay capital gains tax and the charity will receive the full $10,000 value of the stock. Thus, you save on capital gains tax by not realizing the capital gain and you also get to itemize the value of the gift to charity.
When and how should I use donor advised funds (DAF)?
So what if I don’t have enough charitable donations to surpass the standard deduction? There are many strategies that can be used to reduce taxes, and one of them is to itemize deductions in bunched years. This means bunching several years' worth of deductions into a single year, which can then be offset by a larger charitable contribution. Donor advised funds can be an ideal vehicle for this strategy, since they allow you to make a lump-sum contribution that can be used to support multiple charities over time.
This approach can be especially beneficial if you expect your income to increase in the future, since it can help you minimize your tax liability. With careful planning, bunched deductions can be a powerful tool for reducing taxes.
How do donor advised funds work?
A donor advised fund (DAF) is a type of giving program that allows donors to make a charitable contribution, receive an immediate tax deduction, and then recommend grants from the fund over time. The DAF structure offers flexible giving options and can be a useful tool for those who want to support a variety of causes.
The first step in establishing a DAF is to make a contribution to the fund. The donor may contribute cash, securities, or other assets. The contribution is typically made to a trust company, which manages the fund and invests the assets. The trust company also charges fees for its services.
After the contribution has been made, the donor advises the trust company on how to distribute the funds. The trust company then makes grants to the charities selected by the donor. Grant recommendations can be made on a one-time basis or on an ongoing basis.
Donor advised funds offer several advantages for both donors and charities. For donors, DAFs provide an immediate tax deduction and flexible giving options. For charities, DAFs provide a reliable source of funding. Donor advised funds are a great way to bunch charitable donations so you can itemize your deductions every other year or every few years.
What’s better qualified charitable distributions or donations to a donor advised fund?
In the end, many people enjoy the tax advantages that come with charitable giving. But what is the best charitable giving vehicle? It depends on your age and tax bracket. If you are over 70 a qualified charitable distribution (QCD) is a tax-free way to give money to charity and it offsets your ordinary income. If your marginal tax rate is 22% then the QCD is better than donating appreciated stock. If you are in the 12% tax bracket donor advised funds funded with appreciated stock is the better choice if you plan on selling the appreciated stock. If you are younger than 70 using donations in kind is the way to go.
QCDs have some advantages over DAFs. First, QCDs are tax-free, while DAFs are only tax-deductible. Second, QCDs can be used to satisfy required minimum distributions (RMDs), while DAFs cannot. Finally, appreciated stock and real estate can pass to your heirs with a step up in basis upon your death.
What does that mean? It means your heirs won’t owe capital gains on your appreciated property. Traditional IRA retirement funds do not get a step up in basis and are completely taxable upon your death. For these reasons, QCDs may be the better option for those looking to reduce their tax liability through charitable giving. If you believe in giving do it in the smartest way possible!
Sean West, Wealth Management Advisor/ CFP®
Disclosure
This blog reflects the personal opinions, viewpoints and analyses of the White Cloud Wealth Management employees providing such comments, and should not be regarded as a description of advisory services provided by White Cloud Wealth Management. The views reflected in the blog are subject to change at any time without notice. Nothing in this material constitutes investment advice, performance data or any recommendation that any particular security, portfolio of securities, transaction or investment strategy is suitable for any specific person. Any mention of a particular security and related performance data is not a recommendation to buy or sell that security.