Tax Advantages to Using Your IRA for Charity

We have discussed the basics of Qualified Charitable Distributions (QCD) in the past. Now let’s take a look at some of the practical uses for QCDs and how they can be a powerful tax-planning tool

When the Tax Cuts and Jobs Act (TCJA) was signed into law on December 22, 2017, it brought sweeping changes, such as reworking the tax brackets, business taxes, and the alternative minimum tax. The new rules created a tax break for most Americans, but an increase in standard deductions and limitations on certain itemized deductions created issues for those that were charitably inclined.

Starting in 2018, TCJA eliminated personal exemptions and increased the standard deduction from $6,350 to $12,000 per taxpayer. Itemized state and local property tax deductions were also limited to a maximum of $10,000, while mortgage interest deductions were capped at $750,000. These changes significantly reduced the number of taxpayers using itemized deductions, as most couples would fall well short of the $24,000 joint standard deduction. In 2022, the standard deductions for individual and joint filers are currently $12,950 and $25,900 respectively.

Since charitable donations are considered itemized deductions, it has become much harder for a married couple to get tax benefits from their gifts. For instance, let’s look at an example:

• Bob and Mary Smith, both 72, want to give $6,000 to their church every year.
• Other than their charitable contribution, they have $15,000 of itemized deductions: a $10,000 deduction for their property taxes and $5,000 other miscellaneous deductions.
• They give $6,000 in cash to their church.
• They will be unable to use any itemized deductions because the total of their itemized deductions is only $23,000.
• They will be forced to use the $25,900 joint standard deduction, which means they get no tax benefits from their donation.

There are several strategies to get around this, such as bunching, where two or more annual donations are combined into one year. In the Smiths’ example, if they would have combined two years of donations into one tax year, they could itemize because their total deductions would have been $27,000. This would mean that $3,000 of the $12,000 gift could earn tax benefits. Not ideal, but it is better than no benefit. Other strategies like donor advised funds (DAF) can make a useful tool for bunching by smoothing out when the donations are actually given to the charity.

For people who are Bob and Mary’s age, there is potentially another, more beneficial option. Normally, every dollar that comes out of an IRA would be taxed as ordinary income. QCDs are an exception to that rule, but more importantly, are not considered deductions. They come right off the top of your income as if the money was never distributed from your IRA. You must be 701/2 to use a QCD, but for those with significant IRA balances in that age-range, a QCD can allow charitable contributions to benefit not only the charity, but the taxpayer as well. We will quantify that by adjusting the Smith example:

• Bob and Mary Smith, both 72, want to give $6,000 to their church every year.
• They both have significant IRA balances.
• They still only have $15,000 in potential itemized deductions before any charitable gifts.
• Instead of giving cash to the church, they use QCD rules to give $3,000 each to their church directly from their IRAs.
• They will use the $25,900 standard deductions as in the previous example.
• By using QCDs instead of after-tax cash as their donation vehicle, they have essentially converted their charitable contribution to an extra $6,000 in “deductible” tax benefits that they would not have otherwise.
• Depending on their Smiths’ tax bracket, this could save them thousands on their taxes.

There can also be non-immediate benefits of using QCDs over after-tax donations, such as lowering a taxpayer’s IRA balance to reduce required minimum distributions (RMD) for couples who are spending less than their annual RMD. This could also serve to preserve the flexibility of your after-tax money, which can be accessed without the same taxation as IRA distributions for large purchases.

 Not every family will fall into a perfect situation to use QCDs, as in the Smith example. But this powerful tool used effectively can alleviate some of the negative side effects of the new tax law.

Robert W. Baird & Co. Incorporated. Baird does not provide tax advice. Please consult with your tax advisor.

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