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Tax law requires individuals who have reached age 72 to begin taking minimum distributions from their traditional IRA accounts. These are referred to as a required minimum distribution or RMD. The RMD amount is calculated by dividing the value of the IRA account on December 31 of the prior year by the distribution period from the Uniform Lifetime Table, corresponding to the taxpayer’s age. For example, if an individual turns 75 in 2022, the distribution period from the table is 24.6. If the balance in their IRA was $500,000 on December 31, 2021, then the individual’s RMD for the current year would be $20,325 ($500,000/24.6). RMDs are counted as taxable income. The IRS develops the Uniform Lifetime Table using mortality rate data; it has been updated effective with 2022 distributions.
The tax law also permits individuals aged 70½ or over to transfer funds from their IRA accounts to charities in what is referred to as Qualified Charitable Distributions (QCDs). These QCDs are not taxable. In instances where a taxpayer must make required minimum distributions (RMDs), the QCDs count toward the RMD requirement. Thus, in our prior example, if the individual had transferred the $20,325 to a qualified charity in a QCD, the $20,325 would not have been taxable.
However, QCDs are not limited to RMDs. For those with large IRA balances, QCDs can total up to $100,000 annually. Additionally, QCDs are not limited to a single transfer in a tax year as long as the total amount distributed does not exceed the $100,000 annual limit.
Example: Anne wants to contribute to her church’s building fund, the American Cancer Society, and the American Red Cross in the same year. She can do that by having her IRA make separate direct transfers to each charity.
It is important to remember that all individual Traditional IRAs are treated as one for purposes of determining an RMD and that all QCDs must be direct transfers by the IRA trustee to the charity.
Qualified Charitable Distributions can provide significant tax benefits. Here is how this provision, if utilized, plays out on a tax return:
At first glance, this may not appear to provide a tax benefit. However, by excluding the distribution, a taxpayer lowers his or her adjusted gross income (AGI), which helps for other tax breaks (or punishments) that are pegged at AGI levels, such as medical expenses if itemizing deductions, passive losses, taxable Social Security income, and so on. In addition, non-itemizers essentially receive the benefit of a charitable contribution to offset the IRA distribution.
At first glance, this may not appear to provide a tax benefit. However, by excluding the distribution, a taxpayer lowers his or her adjusted gross income (AGI), which helps for other tax breaks (or punishments) that are pegged at AGI levels, such as medical expenses if itemizing deductions, passive losses, taxable Social Security income, and so on. In addition, non-itemizers essentially receive the benefit of a charitable contribution to offset the IRA distribution.
In the past, the tax code did not permit contributions to IRAs by individuals once they reached age 70½, which coordinated with the previous age requirement to begin RMDs and the ability to make QCDs. The age restriction to contribute to IRAs has been eliminated, so now individuals may make IRA contributions at any age provided they have earned income.
Whether intentional or an oversight by Congress, the tax changes did not modify the age at which a taxpayer can begin making QCDs and left it at age 70½ – no longer in synchronization with the revised RMD age of 72.
Unfortunately, that has created a situation that can be detrimental for individuals who have earned income and wish to utilize the QCD provisions and continue to contribute to an IRA after age 70½. The problem is that a Qualified Charitable Distribution must be reduced by the sum of IRA deductions made after age 70½ even if they are not in the same year, causing unexpected tax results for taxpayers that are not aware of this complication. This is best demonstrated by a couple of examples.
Example #1 –
Jack makes a deductible IRA contribution of $7,000 when he is age 71 and another $7,000 contribution at the age of 72. He claims an IRA deduction of $7,000 on his tax return for each year. Then later when he is 74, he makes a QCD of $10,000 to his church’s building fund. Since Jack had made the IRA contributions after age 70½, his QCD must be reduced by the post-70½ contributions that were deducted, and as a result, the $10,000 is a taxable IRA distribution ($10,000 – 14,000 = <$4,000>). However, he can claim the $10,000 to the church building fund as a charitable contribution on Schedule A if he itemizes his deductions.
In the next year, Jack makes a $5,000 QCD to the university where he got his degree. The excludable amount of the QCD is $1,000 ($5,000 – $4,000 = $1,000). The $4,000 is the amount that remained from post-age 70½ IRA contributions that didn’t previously offset QCDs. Jack includes $4,000 as taxable IRA income and can deduct $4,000 as a charitable contribution if he itemizes. No amount of post-age 70½ IRA contributions remains to reduce the excludable amount of QCDs for subsequent taxable years.
Example #2 –
Bob makes a traditional IRA contribution of $7,000 at age 71 and another $7,000 contribution at the age of 72 and deducts the IRA contributions on his returns. Then later when he is 74, he makes a QCD in the amount of $20,000 to his church’s building fund. Since Bob had made the deductible IRA contributions after age 70½, his QCD must be reduced by $14,000. As a result, of the $20,000 QCD, $14,000 is a taxable distribution, $6,000 is nontaxable, and Bob can claim a $14,000 charitable contribution.
All of this can become quite complicated. If you are considering making a Qualified Charitable Distribution and made IRA contributions after age 70½ consider consulting with the tax experts at Cray Kaiser before you make the distribution to ensure you understand the potential tax ramifications.
